Key Takeaways
- Currency traders are focused on the Bank of England’s next moves, as UK interest rate cuts could weaken sterling against the dollar and euro.
- Political risk, with new threats to the UK prime minister’s leadership, could lead to continued sterling volatility.
- Against the dollar and euro, the pound remains below levels seen before the vote to leave the European Union in 2016.
- Economists are looking ahead to 2026 for potential triggers of sterling weakness, including weak UK growth, further interest rate cuts from the Bank of England, and ongoing political risk from UK fiscal policies.
Introduction to the British Pound’s Performance
The British pound has been a subject of interest for currency traders and investors in 2025, with its performance against the US dollar and euro being closely watched. Despite a strong year for the pound against the dollar, hitting multiyear highs, it lost ground against a resurgent euro in a volatile year for currency markets. The pound’s rally against the US dollar was significant, but it remains below levels seen before the vote to leave the European Union in 2016. With one pound currently buying USD 1.35, this is a far cry from autumn 2022, when the pound slumped during Liz Truss’s short-lived run as UK prime minister.
The Pound’s Performance Against the Dollar and Euro
The pound’s performance against the dollar and euro has been influenced by various factors, including interest rate cuts by the Bank of England and political uncertainty in the UK. The euro, as the second-most traded currency after the dollar, has benefited from the shift away from US assets in the trade war era. Strong economic growth in countries like Portugal, Spain, Greece, and Italy, as well as ambitious defense spending plans by Germany, have boosted the attractiveness of holding euro assets. The pound is also lower against the euro than it was before the Brexit vote in 2016, with the UK currency weakening against the single currency in 2025.
The Impact of a Weaker US Dollar on Investors
A weaker US dollar has significant implications for investors, with the euro and other currencies benefiting from the shift away from US assets. The US dollar’s weakness in 2025 likely signals a turning point in its long cycle of strength, although it is not expected to challenge the dollar’s status as a global reserve currency. The Japanese yen is expected to make the biggest gains of all the major currencies against the US dollar in 2026, with the pound forecast to make a gain of 1.5% against the dollar. Analysts at Bank of America say the euro could continue to rally against the dollar in 2026, but think sterling could also rally against the euro if UK economic growth is better than expected in Q1.
The Outlook for UK Government Bonds in 2026
The Bank of England holds the key to the pound’s performance in 2026, with interest rate cuts likely to play a significant role in determining the currency’s value. A strong year for the pound against the dollar came despite a period when UK monetary policy was being loosened, with the Bank of England cutting rates four times in 2025. Lower interest rates reduce the attractiveness of holding a country’s currency and assets, because higher yields can be found elsewhere. However, with sluggish economic growth and a weakening labor market, the Bank of England could play a key role by lowering interest rates further to stimulate economic activity amid falling inflation.
Political Risk and the Pound’s Performance
Political risk is still a live issue in the UK, with at least two separate political revolts hitting the UK prime minister, Keir Starmer, in 2025. Many anticipate 2026 bringing further turbulence as internal Labour Party politics come back to the fore and the May local elections potentially result in a formal leadership challenge. This could lead to a selloff in sterling, as it did at key points in 2025 when market anxiety over the government’s economic plans was at its highest. A challenge to Starmer’s leadership is an unambiguous downside risk to the pound, with a successful leadership challenge likely to see a new chancellor installed with lessened commitment to fiscal consolidation.
Conclusion and Future Outlook
In conclusion, the British pound’s performance in 2026 will be influenced by various factors, including interest rate cuts by the Bank of England, political uncertainty, and economic growth. While the pound’s rally against the US dollar was significant in 2025, it remains below levels seen before the vote to leave the European Union in 2016. The euro is expected to continue to rally against the dollar in 2026, but sterling could also rally against the euro if UK economic growth is better than expected in Q1. As the UK approaches its "terminal" or neutral rate, the Bank of England’s Monetary Policy Committee is likely to remain cautious, and financial markets currently price in a further two rate cuts in 2026. However, the exact timing is uncertain, and sterling is being boosted in the short-term by this uncertainty.