The intensifying power struggle within the UK's ruling Labour Party has prompted a surge in bearish bets against the British pound. Hedge funds and asset managers piled into pound put options last week, wagering on further currency depreciation. The catalyst for this selling wave is the rising possibility that Manchester Mayor Andy Burnham could challenge Prime Minister Keir Starmer's leadership. Burnham's path back to Parliament has recently cleared significant hurdles, sparking deep market concerns over potential fiscal laxity and political instability in the UK.
**Burnham Clears Path to Parliament, Threatening Starmer's Position** On May 14, Labour MP Josh Simmons announced his resignation from the Merseyside constituency seat, explicitly stating he was "making way" for Burnham to return to the House of Commons. Simmons cited the government's failure to deliver needed change for his constituency. The following day, the Labour Party's National Executive Committee approved Burnham's candidacy for the upcoming Merseyside by-election. This marks a crucial step for Burnham toward potentially challenging for the party leadership and, by extension, the premiership, as Labour rules stipulate only sitting MPs can run for leader.
The internal rift within the governing party is widening. UK media reports indicate over a hundred Labour MPs have publicly called for Starmer's resignation. Health Secretary Wes Streeting deepened the crisis by resigning from the cabinet, citing a "loss of confidence" in the Prime Minister. Polls show Burnham leading as the favored successor for Labour leader with 42% support and a net favorability rating of 72%.
Jefferies economist Mohit Kumar noted, "The market is concerned that Burnham could be more left-leaning, potentially pushing the deficit higher. Our base case is for an orderly exit by Starmer, with Burnham likely becoming the next Prime Minister." Mitsubishi UFJ Financial Group added, "While Burnham is not a shoo-in, he has a strong chance. Given the strong shift in support to the 'Reform Party' seen in last week's local elections, this by-election will be particularly noteworthy." The Merseyside by-election, expected as early as June 18, could be a decisive moment for Starmer's political future.
**Options Market Flashes Strong Warning Signals** Political uncertainty is rapidly transmitting to the currency markets. Data from the Depository Trust & Clearing Corporation (DTCC) shows that on May 14 and 15, the trading volume of GBP/USD put options with a notional value of at least £100 million was over six times that of call options. Concurrently, data from CME Group's central limit order book indicated that GBP/USD put option volume last Thursday reached its highest level since April 8, 2024.
Implied volatility in forex options has also spiked. The one-month GBP/USD implied volatility jumped from a previous historic low of 6.3 to 7.5. The risk reversal premium for pound puts over calls hit its highest level since April, reflecting a sudden market repricing of sterling's downside risk. Julian Weiss, head of G-10 FX options trading at Bank of America in London, stated, "As political noise increases, we are seeing demand for GBP puts from both short-term and long-term money accounts."
**Spot Market Sentiment Reverses Amid Multiple Headwinds** Bearish sentiment is not confined to the options market; positioning in the spot market has also shifted notably. Rob Turner, head of e-FX trading at RBC Capital Markets in London, observed that investors held a small net long position in GBP/USD early last week, but by Thursday's close, it had turned into a small net short position.
Traders are increasingly focusing on option contracts covering the June 18 by-election window. The premium for options protecting against pound downside over the next two months relative to upside protection contracts recorded its largest single-day jump last Thursday since September 2.
Sterling faces additional pressures. Beyond the escalating domestic political turmoil and fears that a Burnham government might increase public borrowing and spending while weakening fiscal discipline, a stronger US dollar is applying external pressure. Last week's US CPI data for April showed a year-on-year increase of 3.8%, exceeding expectations. Combined with safe-haven demand driven by Middle East tensions, this propelled the US Dollar Index to a weekly gain of 1.3% to 99.10, its largest weekly rise in two months. The 10-year US Treasury yield climbed to over 4.5%, a near one-year high, and market expectations for at least one Fed rate hike by the end of 2026 have risen to around 50%.
Simultaneously, stalled US-Iran talks have pushed crude oil prices significantly higher, with rising energy costs further supporting dollar buying. Antony Foster, head of G-10 spot trading at Nomura International in London, commented, "We are seeing GBP/USD selling in the market, reflecting both UK political worries and dollar buying linked to higher oil prices and the lack of progress in Iran negotiations." He added, however, that clients are currently "reluctant to chase GBP/EUR lower" in the spot market.
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