EUR/GBP: Political uncertainty drives risk premium – Deutsche Bank

Deutsche Bank’s Shreyas Gopal and Sanjay Raja note that EUR/GBP continues to trade above levels implied by Bank of England (BoE)-European Central Bank (ECB) rate differentials, leaving a measurable risk premium in the Pound (GBP). They argue this reflects ongoing United Kingdom (UK) political uncertainty and higher gilt yields after the energy shock. They also flag upside risks to Bank Rate and rising UK term premia.

Pound holds election risk premium

"To be sure, if the May election results are sufficiently bad for the Labour Party as to see a leadership challenge over the summer, we would expect these risk premia to remain in place in UK FIC markets. Whether they widen further will depend on the policy platform of any potential challengers, and actual measures taken thereafter."

"In that context, we highlight this recent Financial Times report suggesting that the “soft left” of the Parliamentary Labour Party are slowly moving in favour of some welfare spending reforms, which in isolation could be taken as positive by the gilt market, and offer a (partial) offset to any plans for higher spending elsewhere."

"Our basecase is that the BoE does not change Bank Rate, but we have flagged significant upside risks to that view. The potential for rate hikes has risen and we think could start to crystalise late Q2-26/early Q3-26 – depending on the forthcoming BoE decision."

"With political uncertainty having continued, and with gilt yields having moved higher on the back of the still-unfolding energy shock, the pound still trades with a risk premium. On our measure, which compares the spot level of EUR/GBP against the value implied simply by relative pricing of BoE-ECB monetary policy, the risk premium is currently around 2%. While smaller than before last year’s Budget, it is nonetheless still moderate in size."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)