Pound Sterling's Record Positioning Poses Significant Headwind

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A buildup of long positions ahead of a potential interest rate cut on Thursday could hold back the British Pound.

CFTC data showed the net GBP long held by market participants rose to a new all-time high in the week to July 23, amidst ongoing improvement in sentiment towards the UK currency. A long position is a currency market contract taken out by a trader that would deliver positive returns if the Pound rises.

Net GBP long rose 7% to a new all-time high as speculators added 9,281 new long contracts, extending the record long position to 142,183 contracts. "Net GBP longs have ramped up significantly recently, taking combined (speculative, institutional and hedge fund) net GBP longs (USD18.4bn) to the highest since 2007 following the UK election," says Shaun Osborne, Chief FX Strategist at Scotiabank.

Although the developments confirm an improvement in sentiment towards Sterling, it also means positioning risks becoming crowded.

This poses a headwind to further advances and raises the risk of a sharp retreat if the long positioning is squared by traders having to sell their contracts.

Caution on the Pound is rising ahead of Thursday's Bank of England interest rate decision, where an interest rate cut could prompt such a selloff.

Money markets show investors now see a 58% chance of a reduction in Bank Rate from 5.25% to 5%, having seen odds of around 40% just a week ago.

Robert Howard, a Reuters market analyst, says the EUR/GBP exchange rate might extend north to 0.85 if the Bank reduces rates on Thursday (Pound-Euro falls to 1.1765).

He says the Pound-Dollar exchange rate could fall to 1.2844.

"If BoE reduces rates this week, GBP long positions might be lightened," says Howard.

"While we remain of the view that the pound can continue to pick up support, we see this as a less straightforward call now that the market is holding long GBP positions. This positioning implies that the pound may become more sensitive to disappointing news or to dovish takeaways from the BoE which indicates scope for more volatility," says Jane Foley, Senior FX Strategist at Rabobank.