By Matt Boyle
UK Economic Outlook
GBP>EUR rates are currently close to the highest levels seen for around 6 months, offering great opportunities for buyers of Euros with upcoming requirements.
UK inflation remains currently around 1% above the BoE’s 2% target. The BoE acknowledged that it expects Inflation to fall closer to its 2% target around springtime, as CPI cools faster than expected. This, combined with an expected deflationary impact from the Budget, could lead to a looser BoE monetary policy.
The UK labour market is showing signs of weakening – the unemployment rate is currently at an almost 5-year high. Wage growth is also cooling with private sector pay falling below 4% for the first time since 2020.
The BoE forecasts that unemployment could rise to 5.5% in Q2 of this year owing to higher labour costs. A continued weakening in the labour market could prompt the BoE to cut interest rates further, although wage growth, while slowing, remains too high to be consistent with a 2% inflation target.
With the Winter budget now feeling like a distant memory, concerns over the UK’s fiscal position have eased. Chancellor Rachel Reeve has calmed market concerns, allowing the government some well needed breathing space.
However, the UKs fiscal position remains fragile, even if the market is looking through this for now. Government spending has been at record levels across the latter part of 2025. Markets will continue to monitor government spending and public sector net borrowing closely throughout 2026.
To add to the hurdles ahead for the Pound, political unease in the UK could weigh on sentiment. Prime Minister Kier Starmer’s position looks far from secure. Both Starmer and Reeves have been under pressure, and while the Budget appears to have given them more time, there is a sense that a single misstep could result in either being out. Should Labour underperform in the May 2026 local elections, Starmer’s leadership could well be challenged.
Interest rates
The Bank of England cut interest rates four times in 2025 and a total of six times since starting its monetary easing cycle in August 2024. The central bank reduced rates by 25 basis points in March, June, August, and December, taking the benchmark rate to its current level of 3.75%
In the final MPC meeting of the year, the BoE adopted a more cautious tone towards further rate cuts. The BoE minutes reiterated that rates will likely continue to ease gradually. However, they also warned that there is limited room for further cuts as the rate approaches a neutral level. Interestingly, the BoE’s stance was unchanged following the significantly cooler-than-expected inflation data, with a 5-4 vote.
The market is currently pricing in another 25-basis-point rate cut to bring rates to a terminal level of 3.5%. Should inflation cool faster than expected amid slow growth, the BoE could cut rates more quickly to 3% by the end of 2026. Under this scenario, Sterling would likely fall.
The question now for the Pound and indeed the FX market in general is whether the market is too optimistic or not about rate cuts.
With the Pound close to the best levels it has seen since pre-July 2025 having risen surprisingly and against the odds in recent weeks, buyers may want to take advantage now ahead of inflation and BoE announcements at the beginning of February. Equally sellers of Euros should have concerns given the change in Sterling fortune and the BoE’s and MPC’s change in stance.
Certainly, it looks like we are in for a bumpy ride in the months ahead.
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