Key Takeaways
- The Bank of England’s interest rate decisions will significantly impact the pound’s performance against the dollar and euro in 2026.
- Political risk, including threats to the UK prime minister’s leadership, could lead to continued sterling volatility.
- The pound remains below pre-Brexit levels against the dollar and euro.
- Economists forecast modest upside for the pound against the dollar, with potential triggers for sterling weakness including weak UK growth and further interest rate cuts.
- The euro may continue to rally against the dollar, but sterling could also rally against the euro if UK economic growth is better than expected.
Introduction to the Pound’s Performance
The pound’s performance against the dollar and euro has been a significant focus for currency traders in recent years. Despite a strong year for the pound against the dollar in 2025, the currency remains below levels seen before the Brexit vote in 2016. The pound’s value can have a substantial impact on investment returns for those who invest in overseas assets, and its fluctuations can be influenced by various factors, including interest rate decisions and political risk. In 2025, the GBP/USD exchange rate rallied significantly, hitting multi-year highs, but lost ground against a resurgent euro in a volatile year for currency markets.
The Pound’s Performance Against the Dollar and Euro in 2025
In 2025, the pound had a strong year against the dollar, with the GBP/USD exchange rate reaching levels not seen since late 2021. However, the pound is still lower against the dollar than it was before the Brexit vote, when a pound traded around USD 1.50. 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. Despite short-lived rallies in 2022 and 2025, sterling is at a similar level against the euro to where it was five years ago. The pound’s performance against the dollar and euro can be influenced by various factors, including interest rate decisions, economic growth, and political risk.
The Impact of a Weaker US Dollar
A weaker US dollar can have significant implications for investors, particularly those who invest in overseas assets. 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. According to Hong Cheng, head of fixed income and currency research at Morningstar Wealth, the euro is not yet in a position to challenge the dollar’s status, but the Japanese yen is expected to make the biggest gains of all the major currencies against the US dollar in 2026.
The Outlook for UK Government Bonds in 2026
The Bank of England’s interest rate decisions will play a crucial role in determining the pound’s performance in 2026. 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, but it also depends on interest rate moves made by other central banks, such as the Federal Reserve. With sluggish economic growth and a weakening labor market, the Bank of England could lower interest rates further to stimulate economic activity amid falling inflation.
The Role of the Bank of England in 2026
The Bank of England’s Monetary Policy Committee is likely to remain cautious as the UK approaches its "terminal" or neutral rate. Financial markets currently price in a further two rate cuts in 2026, but the exact timing is uncertain. Sterling is being boosted in the short-term by this uncertainty, as investors price out the prospects of a series of rate cuts from the BOE in the coming months. According to Kathleen Brooks, research director at XTB, the Bank of England’s interest rate decisions will be a key factor in determining the pound’s performance in 2026.
UK Political Risk and Its Impact on the Pound
Domestic factors, including political uncertainty, can also influence the pound’s next move. While the Autumn Budget answered certain questions about the government’s fiscal plans, political uncertainty is still a live issue. 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.
Conclusion and Future Outlook
In conclusion, the pound’s performance against the dollar and euro will be influenced by various factors, including interest rate decisions, economic growth, and political risk. The Bank of England’s interest rate decisions will play a crucial role in determining the pound’s performance in 2026, and political uncertainty, including threats to the UK prime minister’s leadership, could lead to continued sterling volatility. Economists forecast modest upside for the pound against the dollar, with potential triggers for sterling weakness including weak UK growth and further interest rate cuts. 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 will be closely watching the Bank’s interest rate decisions in 2026.