The pound has largely shrugged off another change of government and geopolitical shocks this year, outperforming many of its peers, but recent signs of softness in the currency could intensify in the months ahead. Against the euro, sterling has gained roughly 1.6% so far in 2025, while rising 2.8% versus the Swiss franc, 4.9% against the Swedish krona, and 1% versus the Canadian dollar. Over the same period, the pound has held roughly flat against the US dollar and slipped 1.3% against the Japanese yen.

Prime Minister Keir Starmer's resignation on July 20 leaves the UK facing its seventh leader in a decade, with markets now closely watching whether the new administration will stick to the fiscal rules repeatedly emphasised by former Chancellor Rachel Reeves. Under Starmer's swiftly appointed successor, Andy Burnham of the centre-left Labour Party, UK borrowing costs have ticked higher, although this has coincided with a global sell-off in government bonds.

Matthew Ryan, head of market strategy at financial services firm Ebury, said the "smooth and orderly handover of power" has "ruled out a potential source of instability and eased the political risk premium that had been visible in the pound."

UK long-term borrowing costs hit highest level since 1998

In a note released on Friday, Ryan highlighted that the pound has been the "surprise outperformers" among G10 currencies over the past three months, attributing this to the unexpected resilience of the UK economy. After growing 0.6% in the first quarter, UK GDP expanded 0.4% in the second quarter, ranking among the strongest performances in the developed world. Sunny weather and excitement around the FIFA World Cup boosted consumer spending, while business activity has remained surprisingly robust despite a turbulent geopolitical backdrop.

Jane Foley, senior FX strategist at Rabobank, noted that the pound also drew support during the early stages of the Iran conflict in April, when markets had priced in an overly aggressive monetary policy response from the Bank of England due to inflation concerns. The UK is highly vulnerable to rising oil and gas costs, both of which have surged sharply this year, pushing headline inflation toward 3%.

Concerns mounting over the pound's future path

Despite the resurgence of price pressures, the Bank of England has kept its benchmark interest rate at 3.75% throughout the year. Current market pricing suggests a low probability of a rate hike at the central bank's September meeting. In contrast, markets are pricing in a near-certain rate increase from the European Central Bank on Wednesday, with expectations for a Federal Reserve hike later this month also gaining ground. Central bank tightening typically boosts the domestic currency.

Rabobank's Foley pointed out that if the Bank of England signals a dovish stance on September 17, it would leave "the pound further exposed to risk," just as markets prepare for an anxious period ahead of the Burnham government's first annual budget on October 28. In a speech on Monday, the UK's new Chancellor of the Exchequer, John Healey, affirmed his commitment to fiscal discipline while also pledging to pursue more balanced economic growth across the country—a stark contrast to the previous pattern of growth being heavily concentrated in the core city of London.

Allan Monks, UK economist at JPMorgan, suggested that given the backdrop of rising borrowing costs, Healey's remarks indicate a cautious approach to tax and spending changes. In a Monday note, Monks said the budget is likely to continue focusing on devolution, strengthening public control over public services, and enhancing private sector collaboration, but with little change to the macroeconomic outlook.

Ebury's Matthew Ryan believes the budget carries significant political risk and could include "a combination of higher ancillary taxes matched with increased debt issuance to fund Burnham's spending ambitions." These measures could involve adjustments to property purchase taxes and council tax, the introduction of a "mansion tax," and tightening of tax incentives on pensions and individual savings accounts. He added that markets would be highly unsettled by any plan that could dampen economic growth, squeeze the private sector, and simultaneously require more borrowing.