Investing.com– Bank of America is turning more cautious on the British pound, arguing that a shift in how markets view the Middle East conflict is likely to weigh on sterling in the near term.
The bank recommends selling in the low 1.34s, targeting a move to 1.30. The call comes as strategists say a key shift has taken place in market thinking, with investors no longer treating the conflict as short-lived. GBP/USD last traded at 1.3385.
“The ‘short-term’ conflict narrative has now been replaced with a concern that the conflict is likely to be more protracted,” FX strategists led by Kamal Sharma said, adding that markets are increasingly transitioning toward a more defensive, risk-off environment.
That shift is seen as particularly negative for the pound, which had held up relatively well earlier in the escalation. Sharma said renewed pressure in the UK gilt market, alongside political uncertainty ahead of May elections, is creating fresh headwinds for sterling.
The relationship between UK rates and the currency is also changing. The bank noted that the correlation between gilt yields and GBP is turning negative, reflecting growing concerns over fiscal and political risks. With market sentiment toward UK fiscal policy described as fragile, the outlook for the pound appears increasingly vulnerable.
At the same time, the broader macro backdrop is expected to support the U.S. dollar. While the recent pace of dollar gains has slowed, Bank of America said it does not believe the impact of the conflict is fully reflected in markets.
“As the conflict lingers on, the prospect for prolonged energy market disruption increases non-linearly,” Sharma added, pointing to the rising risk of attacks on key infrastructure.
Even in the event of a quick de-escalation, the bank is skeptical that markets would quickly return to a more risk-friendly environment. Instead, it sees continued support for the dollar, with “further potential upside USD asymmetries over the next several months.”
Risks to the trade include a rapid end to the conflict or a smoother-than-expected outcome from the U.K.’s May elections, particularly if they pass without a change in leadership.
