Pound Sterling Highly Exposed to a Market Correction

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The British Pound faces significant downside risks in the event of a shift to risk-off sentiment in global markets, according to a research note from BNP Paribas.

The bank identifies Pound Sterling as one of the most vulnerable currencies among G10 peers, driven by structural weaknesses and heightened sensitivity to investor risk appetite.

"Currently, this yields NZD and GBP as most sensitive to risk-off, while the JPY and CHF could outperform in the G10," says Joshua Wilcock, FX Strategist at BNP Paribas.

BNP Paribas highlights that the Pound's elevated carry status has increased its exposure to equity market fluctuations, making it more sensitive to deteriorating global risk conditions.

The warning comes at a time of risk-on market conditions consistent with an ongoing bull market in stocks, which have facilitated GBP exchange rate gains.

This week's setback in the Pound-to-Euro exchange rate recovery is consistent with a decline in the U.S. S&P 500 index, which is taken as a proxy for global investor sentiment.

Above: GBPEUR (top) and the U.S. S&P 500 index.

The decline has been relatively shallow, but the sensitivity confirms the Pound's vulnerabilities to wider sentiment and losses would be far more significant in a bigger market correction.

"The GBP stands out in the screen as it suggests scope for a change in behaviour, having become one of the high yielders in G10," says Wilcock. "For the GBP, vulnerabilities are revealed consistently across the variables."

One vulnerability is the UK’s worsening net international investment position (NIIP) and persistent current account deficit have left the currency reliant on foreign capital inflows.

"The persistent current account deficit and wide fiscal deficit has created a reliance on foreign investor inflows," explains Wilcock.

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The research also underscores sterling’s vulnerability to a broader economic slowdown alongside emerging market high-yielders such as the Brazilian real and the Hungarian forint.

BNP Paribas says this leaves the path for GBP outperformance "a narrow one considering uncertainties around global trade and financial conditions."

"For the GBP, with this sensitivity to risk-off we still think the GBP may be underhedged for GBP downside, so we position for this via a 1.15 GBPUSD digital put," says Wilcock.

In contrast, the Japanese yen and Swiss franc are expected to outperform in risk-off conditions due to their safe-haven status.

Can the stock market rally continue? The answer could be key to GBP direction in 2025.

BlackRock, the world's largest asset manager, thinks it can.

"We still think U.S. equities can outperform in 2025, led by tech, even as Europe’s start the year strong. Yet we broaden our risk-on view, upgrading Europe stocks," says Jean Boivin, Head of BlackRock's Investment Institute.

BlackRock thinks a lot of bad news is already priced into European equities and prospects of good news could help them push higher.

"One example: Possible de-escalation in the Ukraine war. Reduced reliance on Russian gas brought European energy prices down from 2022’s highs. See the chart. A form of peace agreement could lower energy prices further," says Boivin.