Pound Sterling Faces Political Test as By-Election Looms

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Above: Zack Polanksi's Green Party are expected to win Thursday's by-election. Photo: David Mirzoeff/The Green Party.

The British pound heads into Thursday's Gorton and Denton by-election under pressure, with markets bracing for an outcome that could amplify political risk and weigh further on the currency in the near term.

Betting platform Polymarket currently assigns the Green Party a 70% probability of winning the seat, with Reform at 20% and Labour trailing at just 10%, confirming a Labour defeat is the base case.

A constituency-specific poll for the Gorton and Denton by-election on February 20 by pollster Omnisis showed the Green Party leading with 33% of the vote, with Reform in second place on 29% and Labour third on 26%.

Such an outcome would intensify scrutiny on Prime Minister Keir Starmer and reinforce concerns that policy risks will skew leftward.

"Political risk events are in focus this week in the UK," says a weekly note from Barclays covering the pound. "Losing this erstwhile safe seat could yet again generate noise regarding Starmer’s future as PM and associated policy risks, but in any event, this is just the first test in a difficult few months leading up to May’s local elections."

For currency markets, the issue is not about the personality who leads Labour, but how the leader shifts spending and borrowing priorities in light of the UK's growing debt burden.

Barclays says the ideological balance within Labour is likely to shift leftward when Starmer goes, particularly if the left-leaning parliamentary Labour Party perceives the threat coming from the Greens and not the right-wing Reform.

This is a concern for markets and the pound.

"The more fundamental issue remains that the so-called soft left wing of the Labour party has increased its influence, which we think justifies a higher fiscal premium in the pound. By how much is unclear at the moment, as the ultimate outcome is very much path dependent, but a c.0.87 EURGBP premium is far from excessive," says Barclays.

That framing suggests the pound’s current risk premium against the euro, estimated by the bank at around 1%, may not fully capture the potential for policy drift toward looser fiscal settings.

Enrique Diaz-Alvarez, Chief Economist at Ebury, says the political backdrop is likely to dominate the near-term narrative, even if macro data show signs of improvement.

“While the turn for the better in the performance of the UK economy could support the pound in the near-term, we suspect that this will be overshadowed by political risks, with the future of Prime Minister Starmer still shrouded in doubt. The key by-election in Gorton and Denton on Thursday will probably be telling, with Labour looking likely to lose the seat to either the Green Party or Reform.”

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Technical dynamics add to the pound's vulnerability.

Antonio Ruggiero, FX and Macro Strategist at Convera, notes that sterling’s recent support structures have begun to give way.

“The event is usually negligible, but with Starmer’s position strained by ongoing backlash, it carries greater significance. A Labour win would ease political uncertainty but not eliminate it, with May’s regional elections standing as a bigger test of the Prime Minister’s leadership. In the meantime, media leaks on this topic are likely to keep sterling on the softer side.”

He adds that, "Piercing through the weakening technical armours that has supported GBP/USD and GBP/EUR since November, sterling now looks more vulnerable."

The pound to euro exchange rate trades down 0.85% in February at 1.1443, and the pound to dollar exchange rate is at 1.3481, down 1.50% this month.