Hedge Funds Bet Against Pound as Starmer Crisis Deepens

by David Finnerty, Vassilis Karamanis of Bloomberg News, 2/9/26

Hedge funds are betting on more pound weakness as UK Prime Minister Keir Starmer’s future hangs in the balance.

Sterling fell 0.7% as much as to 0.8742 per euro on Monday, the weakest since Jan. 21, as the UK political crisis deepened after Starmer’s chief of staff quit on Sunday over the appointment of Peter Mandelson as ambassador to Washington. Pressure on the pound mounted last week on concerns around the prime minister’s grasp on power and as the Bank of England came within one vote of cutting interest rates.

Renewed political uncertainty dragged gilts lower. UK 10-year yields rose as much as eight basis points to 4.60%, their highest level since November.

“The risk of Starmer being replaced by a more left-leaning candidate increases the likelihood of more expansionary fiscal policy, an increase in the debt burden and a possible abolishment of the fiscal rules,” said Kirstine Kundby-Nielsen, FX analyst at Danske Bank. “Coupled with elevated uncertainty this would be negative for UK markets.”

Starmer was hit by the departure of a second senior aide in 24 hours when his communications director quit on Monday, while Scottish Labour Leader Anas Sarwar urged Starmer to leave his post. With the sense of crisis around 10 Downing St. growing, UK cabinet ministers including the Chancellor of the Exchequer Rachel Reeves voiced their support for the Prime Minister.

As was the case around the November budget, options traders preferred the common currency as the best vehicle to concentrate on UK-specific risks. The premium to hedge against a drop in sterling drop versus the euro over the next month, compared to a gain, jumped to the highest since late November last week and by the most since July.

Trading volume of euro-sterling options was the most elevated since 2019 on Feb. 5, according to data from The Depository Trust and Clearing Corp. The volume of call options, which gain if sterling weakens versus the euro, was 50% larger than that of put options, which increase in value if the pound rises.

Hedge fund flows into “euro-pound remained one‑way, with heavy topside buying,” said Thomas Bureau, global head of FX option trading at Societe Generale, referring to demand for call options following the market moves on Feb. 5. “The pound has traded with EM‑style volatility, driven by global dollar strength and hypersensitivity to geopolitical headlines.”

The latest developments are a further setback for the pound after it weakened more than 5% versus the euro last year. Strategists at Goldman Sachs Group Inc. see sterling weakening 6% against the euro in 12 months while Nomura Holdings Inc. expects a decline of 3% by end-April.

Sterling was already under pressure before the BOE decision given that Starmer’s position as the UK’s leader was looking increasingly tenuous, according to RBC Capital Markets.

“In particular, we saw demand for EUR/GBP topside,” said Jamie Sanders, London-based director of foreign-exchange options trading at RBC. That demand led the pair’s implied volatility, a measure of expected price swings, to reprice “much higher,” he added.

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Expected volatility over the next month is at the highest since December. In low-probability structures, DTCC data show a clear preference for buying euro-pound topside exposure, suggesting markets see tail risks skewed toward further sterling weakness.

While there’s sizable interest clustered around the May 7 UK local elections, April contracts have seen heavier activity. That’s likely due to pre-vote hedging or early positioning. Demand for options paying out above the 0.90 strike, a level last seen in 2022, accounts for about 15% of bullish flow traded last month and roughly 50% of total call volume for expiries beyond June.

Jane Foley, FX strategist at Rabobank, sees a risk of euro-pound edging higher heading into the middle of the year and cable moving lower, assuming the dollar avoids another sharp selloff. Starmer had been expected to face a challenge to his leadership after the local elections in May but that may now happen earlier, she added.

“The market will be very wary of UK political jitters particularly if it starts to look likely that the next PM may come from the left wing of the Labour party,” Foley said.

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Bloomberg News provided this article. For more articles like this please visit bloomberg.com.

Hedge Funds Bet Against Pound as Starmer Crisis Deepens

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