Why Rabobank Sees Risks That Could End Sterling's Rally

Sterling has been the strongest major currency this month, rising against the dollar and the euro. The rally followed softer US data and a repricing of Bank of England rate expectations. Rabobank strategists argue the market is overlooking two risks that could reverse these gains, according to a note this week.

The first risk is political. The UK's fiscal position remains fragile after the government's spending plans drew criticism. A general election this year could add to uncertainty, especially if the opposition Labour Party, which has proposed higher spending, looks likely to win. Rabobank said political risk is not fully priced into sterling.

The second risk is monetary policy. Strategists at the Dutch bank expect the Bank of England to cut rates sooner than the market currently prices. The Federal Reserve, by contrast, may hold rates steady for longer. That narrowing of the rate advantage has been a key support for cable. If it disappears, the pound could lose its footing.

If UK inflation data continues to cool, the central bank's tone could turn more dovish at its next meeting. That would remove a key pillar of sterling's strength. Rabobank's view is that the market is too optimistic about the pound's resilience.

The next catalyst is the Bank of England's rate decision in May. Until then, sterling's direction will depend on economic data and political headlines. A weaker pound would help UK exporters but could push import prices higher, complicating the inflation outlook. The trade-off is familiar to the BoE.

Rabobank expects the pound to give back some of its recent gains if the risks materialise. For a broader view of the GBP/USD profile, see the profile.