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Morgan Stanley says the pound looks set to defy consensus and strengthen in the coming months.
In a mid-year currency research update, analysts say the thing the pound should deliver an "upside surprise."
"We think investors are generally more concerned with GBP downside risks than upside risks. The result is that GBP/USD rising above 1.40 is a likely underdiscussed – and underpriced – risk," say analysts.
That outperformance will nevertheless require some helpful tailwinds from the Bank of England which must pivot in a 'hawkish' direction, i.e. advocate for, and deliver, higher interest rates.
If this does happen, GBP would "outcompete its G10 peers on carry," says Morgan Stanley.
Carry refers to the carry trade, an investment strategy where investors borrow in a low-interest-rate currency and use the funds to buy higher-yielding assets or currencies, profiting from the interest-rate difference as long as exchange rates remain stable or move in their favour.
"We are also watching AI adoption in the UK closely; an increase in potential growth and neutral rates could offer a sustainable boost to the currency," adds Morgan Stanley.
The bank's recent research into AI adoption shows the UK is likely at the forefront, which is showing signs of boosting productivity.
"GBP/USD can rally to 1.39, buoyed by the tailwinds of a weaker USD, but ultimately we think GBP will lag its European and global risk-sensitive peers thanks to underpriced BoE dovishness and investor concern over political and fiscal risk premium," says Morgan Stanley.