Sterling holds ground amid geopolitical risks and UK election uncertainty

The British pound remained broadly stable on Tuesday, as traders turned their attention to the upcoming UK local elections and escalating tensions between the United States and Iran in the Strait of Hormuz.

Sterling was little changed at $1.3539 and edged slightly higher against the euro, trading at 86.31 pence.

Market participants appeared cautious, balancing domestic political developments with ongoing geopolitical uncertainty.

Investors are closely monitoring Thursday’s local elections, which could increase pressure on Prime Minister Keir Starmer and potentially influence market sentiment toward the currency.

Geopolitical tensions weigh on sentiment

The fragile truce in the Middle East showed signs of strain, as the United States and Iran exchanged fire in the Gulf region and competed for control of the Strait of Hormuz.

The situation has heightened uncertainty across global markets, with currencies reacting to shifting risk sentiment.

Despite these tensions, sterling has held up relatively well compared to its peers. However, analysts suggest that continued instability in the region could still pose risks to the currency.

BoE rate expectations underpin sterling

Sterling’s resilience has been partly supported by changing expectations around interest rates from the Bank of England.

“The biggest story for sterling since the start of this war has been the change in money market pricing of Bank of England interest rate hikes,” Jane Foley, head of FX strategy at Rabobank, said, as reported by Reuters.

“Before the war, the market was expecting cuts and then they swung very quickly into expecting hikes and as a consequence of that, sterling has been one of the better G10 performers since the start of this war,” she added, according to Reuters.

Money markets are currently pricing in at least two 25-basis-point rate hikes from the Bank of England this year, with a strong possibility of a third.

The central bank recently kept its policy unchanged but indicated that further rate increases remain on the table.

Economic weakness and elections pose downside risks

Despite the support from rate expectations, concerns about the UK economy persist.

Foley noted, as mentioned in a Reuters report, that economic weakness could be exacerbated by higher interest rates, which may eventually weigh on the pound.

At the same time, domestic political risks are adding another layer of uncertainty.

The May 7 local elections are seen as a potential turning point, with opinion polls suggesting that Starmer’s Labour Party could face significant losses.

“If the likelihood of Starmer's resignation increases, this will weigh on the pound,” Michael Pfister, FX analyst at Commerzbank, said in a note.

Markets are also wary of the implications of any leadership change.

Investors are concerned that a more left-leaning successor could put pressure on public finances, further dampening confidence in sterling.

Overall, while the pound has shown resilience, a combination of geopolitical tensions, monetary policy uncertainty, and domestic political risks continues to shape its near-term outlook.