Sterling Rally: BoE Cuts and Dollar Weakness

Introduction

Last week brought decisive moves in the British pound: sterling strengthened against the US dollar while lagging versus the euro. Concrete policy signals, holiday-thinned trading and fresh macro data drove swings in GBP pairs. This article synthesises the key drivers — Bank of England (BoE) policy expectations, dollar dynamics, inflation trends and trade flows — and outlines likely near-term implications for traders and corporate FX managers.

Why Sterling Moved This Week

Bank of England policy and market pricing

The BoE’s shift toward easier policy expectations remains central. Following the December decision that left the policy rate at 3.75%, markets increasingly price further cuts in early 2026. That prospect is a double-edged sword: it caps long-term sterling upside but has, paradoxically, supported short-term gains as investors rebalanced positions into year-end and discounted faster Fed easing in the US.

Dollar weakness amplified GBP gains

Global risk sentiment and expectations of multiple Federal Reserve rate cuts next year weakened the dollar across asset classes. GBP/USD rose above the $1.35 area during the thin December session, reflecting both a softer greenback and GBP’s year-end positioning. With a weaker dollar, many dollar-based hedges and carry trades were unwound, giving the pound room to rally in the short term.

Exchange-Rate Moves: Facts and Figures

GBP/USD: notable strength

Sterling climbed to roughly $1.35–1.36 late in the week, marking one of its strongest stretches against the dollar in months. On an annual basis, sterling posted strong gains versus the dollar in the most recent reporting period, underlining a pronounced recovery from earlier weakness.

GBP/EUR: the divergence story

Against the euro, sterling underperformed. GBP/EUR hovered near the mid-€0.87 range, which translated into a multi-month low for the pound versus the euro over the period. The divergence highlights regional dynamics: while US policy expectations helped GBP/USD, stronger euro performance and relative UK growth concerns weighed on GBP/EUR.

Underlying Drivers: Inflation, Trade and Demand

Disinflation and imported goods

Recent data point toward easing inflationary pressures in the UK. A wave of lower-priced imports — notably from China — has contributed to softer goods inflation, and headline inflation has been moving down from its peak. Lower inflation reduces pressure on the BoE to maintain restrictive rates, reinforcing expectations of further cuts and exerting downward pressure on sterling over the medium term.

Domestic demand and labour-market signals

Consumer spending and labour-market indicators have shown caution. Surveys suggest households remain subdued even as inflation eases. Weaker domestic demand can slow wage growth and economic momentum, further supporting the narrative of future BoE easing and keeping a lid on GBP strength versus currencies tied to firmer regional growth.

Implications for Traders and FX Managers

Short-term tactical ideas

• Fade extreme moves during thin liquidity: year-end flows produced outsized intraday swings; expect reversals when normal volumes resume.
• Exploit USD softness: momentum trades on GBP/USD remain viable while dollar easing expectations persist; set tight stops for volatility.

Medium-term positioning

Positioning should reflect the probability of BoE cuts versus the Fed and ECB. If the BoE follows through with additional cuts while the Fed eases later or less aggressively, GBP/USD could maintain gains. Conversely, if UK growth disappoints further or euro-area strength accelerates, GBP/EUR downside risk increases. Hedging EUR exposures remains prudent for corporates with euro-linked revenues or costs.

Scenario Outlook

Base case (most likely)

Markets price two to three BoE cuts in early-to-mid 2026 while the Fed eases gradually. Sterling stays supported versus the dollar in the near term but faces sideways-to-lower pressure against the euro. Volatility spikes around UK labour and CPI releases.

Alternative case (risk to watch)

If UK data surprises on the downside — notably employment or retail activity — the BoE could signal a more aggressive easing path, prompting a sharper fall in GBP, especially versus the euro. Conversely, a stronger-than-expected euro shock or sudden dollar retracement would reshape pair-specific moves.

Conclusion

This week’s sterling dynamics were driven by a clear interplay between BoE easing expectations and a softer US dollar. GBP’s outperformance against the dollar and underperformance versus the euro reflect divergent policy outlooks and regional economic signals. Traders and FX managers should balance tactical opportunities from current momentum with disciplined hedging against scenarios where UK data and policy signals tilt aggressively dovish.