Currency traders are closely monitoring the Bank of England for potential interest rate cuts that could weaken the pound against the dollar and euro. Political risk, including threats to the UK prime minister’s leadership, adds to sterling volatility. Despite gains, the pound remains below pre-Brexit levels against both currencies.

In 2025, the pound strengthened against the dollar but weakened against the euro. Economists foresee triggers for sterling weakness in 2026, such as sluggish UK growth, further Bank of England rate cuts, and ongoing political risk. Morningstar analysts predict modest GBP gains against the dollar and euro in early 2026.

The pound’s performance impacts investors holding overseas assets, with a strong pound lowering returns on dollar assets and flattering euro-denominated assets in 2025. GBP/USD rates have returned to late 2021 levels, far from the 2022 slump under Liz Truss. Despite recent gains, the pound remains weaker than pre-Brexit levels against the dollar and euro.

Strong growth in Eurozone countries and defense spending in Germany have boosted the euro’s appeal. Morningstar’s Hong Cheng notes the euro’s rise but believes it’s not yet a threat to the dollar’s dominance. Analysts predict the Japanese yen to make the biggest gains against the dollar in 2026, with the pound and euro seeing modest movements.

The Bank of England’s interest rate decisions are crucial for the pound’s performance in 2026. Rate cuts in 2025 didn’t deter the pound’s rise, as economic factors and global central bank policies played a role. Market uncertainty surrounds potential rate cuts in 2026, impacting sterling’s short-term performance amid mixed forecasts.

UK political risk remains a key factor in sterling’s outlook. Political uncertainties, including potential leadership challenges and internal party dynamics, could trigger sterling selloffs in 2026. Analysts highlight the impact of leadership changes on the pound, with market reactions already factoring in current political climate.

Read more at Morningstar: What’s the Outlook for GBP in 2026?