Will Bank of England Still Cut Rates in 2026? Falling Inflation Favors Loose Monetary Policy, Pound Exchange Rate May Struggle to Sustain Strength.

TradingKey - The performance of the British pound in 2026 is undoubtedly one of the most noteworthy focuses for investors in the foreign exchange market. Having undergone a structural shift in 2025 characterized by a "low start and high finish," GBP/USD successfully broke out of its two-year trading range and stabilized near 1.35 by year-end, laying the groundwork for its performance in 2026.

However, the Bank of England's wavering monetary policy, inflation stickiness, and the tug-of-war with economic weakness have all made the future direction of the pound highly uncertain. Will UK inflation remain low in 2026? Will the Bank of England continue to cut interest rates? Will the pound extend its strength or peak and retreat in 2026?

BoE May Cut Rates Cautiously in 2026; Interest Rate Differential Advantage Supports Sterling Strength

Monetary policy is the core variable affecting the pound's exchange rate. Looking back at 2025, the Bank of England initiated a gradual rate-cutting cycle, totaling 75 basis points for the year and lowering the benchmark interest rate to 3.75% by year-end. However, the pace of cuts was significantly slower than that of the Federal Reserve, which was a key support for the pound's strength last year.

Moving into 2026, the Bank of England's monetary policy path has become clearer, with "cautious and gradual" becoming the core tone.

According to recent decisions, on February 4, 2026, the Bank of England's MPC voted by a narrow 5-4 majority to maintain the benchmark interest rate at 3.75% , marking the sixth consecutive time the bank has held rates steady, with the last cut occurring in August 2024.

From the results of the resolution, four members advocated for a 25-basis-point cut to 3.5%, highlighting the intense "tug-of-war" between hawks and doves within the MPC.

Regarding the pace of rate cuts throughout 2026, the market and institutions have reached a preliminary consensus, though slight differences remain. Goldman Sachs adjusted its rate-cut expectations at the end of 2025, delaying the previously anticipated cuts in February, April, and July to March, June, and September—each by 25 basis points—with the benchmark rate expected to drop to 3.0% by year-end.

The Federal Reserve, after cumulative rate cuts of 75 basis points in 2025, is likely to continue its easing cycle in 2026. In contrast, the Bank of England's more restrained pace of cuts will maintain a relatively stable interest rate differential between the UK and the US, thereby driving the pound higher.

UK Inflation Continues to Cool, Nearing Target

Since 2025, UK inflation has shown a continuous cooling trend, creating conditions for a shift in monetary policy in 2026. However, the stickiness of core inflation remains a concern, while excessively low inflation could prompt further easing by the central bank, potentially weighing on the pound's performance.

In November 2025, the UK Consumer Price Index (CPI) rose 3.2% year-on-year, a significant drop from 3.6% in October and the lowest level in eight months, coming in below economists' expectations of 3.5% and the BoE's forecast of 3.4%. While December's CPI ticked up slightly to 3.4%, the overall cooling trend remained intact.

Looking ahead to 2026, the Bank of England is relatively optimistic about inflation, expecting it to fall more rapidly starting in April due to policies in the 2025 budget and lower wholesale natural gas prices. Inflation is projected to drop to 2.1% in the second quarter of 2026, nearing the 2% target.

Goldman Sachs maintained its bullish stance on the pound after adjusting its rate-cut expectations, forecasting that GBP/USD will gradually climb to around 1.38 by the end of 2026. The firm believes the BoE's cautious easing strategy will sustain the UK-US rate differential, while improved fiscal stability from consolidation will further enhance the pound's appeal. However, a deeper-than-expected recession could trigger a temporary correction in the currency.

Weak UK Economy: Strong Growth Unlikely in 2026; Pound May Weaken

The UK economy is currently at a crossroads of "disinflation and stagnation," with weak domestic demand, low business confidence, and increasing external imbalances, leaving the foundation for recovery fragile.

In October 2025, UK Gross Domestic Product (GDP) fell by 0.1% month-on-month, continuing the contraction from September and marking a second consecutive month of negative growth. Preliminary third-quarter GDP grew just 0.1% quarter-on-quarter, significantly below the second quarter's 0.3% and market expectations of 0.2%. Potential GDP in the fourth quarter grew only 0.1%, as growth momentum remained weak.

The Office for Budget Responsibility (OBR) lowered its 2026 GDP growth forecast from 1.9% to 1.4% and revised the medium-term potential productivity growth rate from 1.3% to 1.0%.

The International Monetary Fund (IMF) cut its 2026 UK growth forecast from 1.5% to 1.4%.

UBS's forecast is relatively moderate, suggesting that GBP/USD will extend its strength in 2026, trading primarily within the 1.33 to 1.40 range, and potentially reaching a high of 1.40 by September 2026. UBS noted that cooling inflation and a moderate economic recovery in the UK would support the pound, while continued rate cuts by the Fed would weaken the dollar, indirectly boosting the sterling.

JPMorgan strategist Matthew Landon stated that the BoE's inclination toward rate cuts and the weak economic recovery will limit the pound's upside, especially as policy divergence between the BoE and the Fed widens. JPMorgan predicts that GBP/USD may fluctuate between 1.30 and 1.38 in 2026, with the potential to break below 1.30 if the economic recovery falls short of expectations.