Overview
ING Economics said on Thursday that sterling’s month-long rally versus the euro is largely the product of market positioning, carry trades and merger-and-acquisition (M&A) flows, rather than a clear improvement in the United Kingdom’s economic fundamentals. The broker predicts that those recent gains will be relinquished as fiscal risks re-emerge.
Near-term exchange-rate outlook
ING’s economists put a year-end target for EUR/GBP at 0.88, rising further to 0.90 by 2027 from prevailing levels near 0.85. For the dollar pair, GBP/USD is expected to move within a 1.32-1.36 range, a path that assumes the U.S. Federal Reserve refrains from further rate hikes in this cycle and the dollar softens.
What powered the recent rally
The firm observed that sterling has appreciated roughly 2% against the euro over the last month, but stressed that this appreciation does not reflect a classic revaluation of UK assets. Instead, ING attributes much of the move to a short squeeze. Speculators had established sizeable short positions in sterling ahead of early May local elections amid expectations that poor results could end Prime Minister Keir Starmer’s tenure. When sterling did not fall after the election outcomes, those short positions were forced to cover.
ING pointed to a spike in the risk reversal metric - the premium for purchasing a EUR/GBP call relative to an equivalent put - which climbed to levels not seen since April 2025, a period the broker notes coincided with global market turbulence following President Donald Trump’s 'Liberation Day' tariffs. The failure of sterling to slide after the election left the market exposed to this squeeze dynamic.
M&A flows and their limits
The bank also cautioned against placing too much emphasis on merger-and-acquisition activity as a durable driver of currency moves. On some measures, pending and completed deals for UK companies this year amount to £220 billion, and inbound deal announcements have reached record levels in sectors such as financials, consumer staples and industrials.
However, ING highlighted that over the past 25 years net portfolio flows have typically been nearly five times the size of net direct investment flows, and added that M&A flows "rarely drive sustained moves in currencies."
Divergent market signals
ING noted an apparent disconnect between sterling and the gilt market. While a UK risk premium is still embedded in gilts, that premium has faded in the currency market. The broker interprets this as two markets conveying different messages about the health of the UK economy.
Monetary policy and the path of EUR/GBP
Looking ahead, ING said the principal determinant of the EUR/GBP exchange rate will be Bank of England policy. The broker expects UK policy rates to remain unchanged, while forecasting that the European Central Bank will raise rates once more to 2.50% within the next six to nine months. That anticipated divergence in policy settings would imply upward pressure on EUR/GBP.
Fiscal backdrop and issuance
On fiscal matters, ING flagged mounting spending pressures across defence, health and social care, together with rising debt interest costs. The firm observed that gilt issuance is declining - from £303 billion in fiscal year 2025 to £246 billion in the current fiscal year - but warned that Chancellor Andy Burnham’s stated openness to larger fiscal changes, including a possible increase in the tax-free allowance, leaves open the chance of a bolder autumn budget. Burnham’s first budget is anticipated in October or November.
Implications for markets
ING’s central message is that the recent strengthening of sterling may not be sustainable and could be reversed as fiscal realities reassert themselves. The combination of a short-covering-driven rally, record inbound M&A announcements that historically do not permanently alter currency valuations, and a gilt market still reflecting a UK risk premium underpin the broker’s cautious outlook for the pound.
Conclusion
In ING’s assessment, the pound’s recent move higher is more symptomatic of market dynamics than of a persistent improvement in the UK’s underlying economic picture. With rate differentials, fiscal pressures and issuance trends all in play, ING forecasts a higher EUR/GBP over the medium term and a restrained range for GBP/USD.