(Bloomberg) -- A sharp slump in the pound is imperiling billions of dollars worth of bets on further strength.

The British currency is wrapping its biggest weekly drop of the year after the Bank of England laid the groundwork for a shift to interest-rate cuts, torpedoing a view among traders that the UK central bank would take longer than its peers in Europe and the US to act. 

It’s a rapid about-face for markets. With the pound outperforming more than 90% of global currencies just two weeks ago, speculative investors — a category that includes hedge funds and asset managers — had boosted bets in favor of sterling to the highest since July 2007, worth some $5.5 billion as of March 12. 

Traders pared a portion of those long bets in the week ahead of the BOE’s decision. But non-commercial investors — a group that includes asset managers as well as hedge funds and other speculative market players — still held a sizable net long position of approximately $4.2 billion, according to the latest data through March 19 released Friday by the Commodity Futures Trading Commission. 

Those billions of wagers now look overdone, and market participants warn a rapid unwind could prompt a deeper selloff in the pound.

“The risks of a prolongation of the short squeeze look high,” said Roberto Cobo Garcia, head of G-10 FX strategy at Banco Bilbao Vizcaya Argentaria SA in Madrid. “With the BOE poised to cut sooner than expected, and with stretched positioning and valuations, the trend may have started to revert.”

The pound’s drop also boosted demand for options that payout if the currency falls. So-called risk reversals — a barometer of market positioning that compares the demand to buy a currency versus the appetite to sell — now show the most bearish sentiment for sterling since late October.

It all comes as traders increased bets the BOE will deliver its first quarter-point cut in June, as two of the most hawkish members dropped their calls for hikes on Thursday’s decision that left rates steady at 5.25%. That means the UK would move in lockstep with the Federal Reserve and the European Central Bank, which are also seen cutting for the first time on that month.  

Earlier this year, expectations were euro-area and US policymakers would act sooner and deliver more cuts. Now, the amount of easing priced in for the BOE — about 80 basis points — is widely in line with what’s seen coming from the Fed. Bets are slightly more aggressive for the ECB, at around 90 basis points. 

“This is a clear shift in tone, and it will make people more cautious about the UK rate outlook being that different than other central banks,” said Dominic Bunning, head of European FX research at HSBC Bank Plc. “It takes juice out of the pound.”

Bunning expects the pound to fall to $1.20 in the second half of the year, when the BOE starts to cut rates. On Friday, it traded at $1.26, down 1.1% this week.

Neil Mehta, a portfolio manager at RBC Bluebay Asset Management, lists other risks to the pound this year, including the prospect of a change in the UK government following a vote expected later in the year.

“The combination of political uncertainty in the UK and the risk of a stagflationary environment in the second half this year will be negative for the pound,” said Mehta, adding that he expects sterling to fall toward $1.15 in the second half of the year.

--With assistance from Carter Johnson.

(Updates throughout to include latest CFTC positioning data, market pricing starting in 2nd paragraph)

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