Political Uncertainty, BoE Rate Cuts Leave GBP Exposed

The British Pound remains under pressure after slipping against both the euro and the dollar, leaving Sterling one of the weakest performers in the G10 so far this year.

UK economists at Rabobank argue the currency stands out for two key reasons: rising political uncertainty at home and clear expectations that the Bank of England will cut interest rates further in 2026.

Despite Labour’s commanding majority at the 2024 general election, Prime Minister Keir Starmer’s position is described as “far from secure.”

Opinion polling has deteriorated and electoral tests, including today’s Gorton and Denton by-election and this May’s coming local elections, risk reviving speculation about a leadership challenge.

Rabobank warns that renewed political instability would likely unsettle GBP investors, particularly if a viable candidate were to emerge from the left wing of the Labour Party.

Monetary policy is the second headwind.

The BoE is one of only two G10 central banks, alongside the Federal Reserve, where markets are confident further rate cuts are coming this year.

Last month’s narrow 5-4 vote split was seen as a dovish surprise, and markets now anticipate a 25bp reduction at the March meeting, with two further cuts priced over the coming year.

While this relative dovishness versus the European Central Bank has weighed on Sterling, Rabobank suggests much of that divergence is now in the price.

The implication is that political developments may increasingly drive short-term moves.

Inflation pressures are easing but remain above target. Headline CPI has slowed to 3%, unemployment has risen to a multi-year high and wage growth is cooling – developments that support further easing.

However, inflation is not yet fully tamed, leaving the BoE walking a fine line.

Rabobank also highlights that MPC member Megan Greene recently questioned the assumption that central banks must “follow the Fed,” noting there may be “a strong case for the BoE to do the exact opposite.”

The bank views this as part of the broader debate rather than a sign of imminent policy reversal.

On the fiscal side, risks appear more contained.

The upcoming Spring Statement is expected to be low key, with no major fiscal shift anticipated. Moderating gilt issuance next year could help stabilise the bond market and reduce currency volatility.

Even so, Rabobank’s overall assessment remains cautious.

“With political risks rising and a dovish central bank, we expect EUR/GBP to edge higher in the months ahead.”

In short, unless political stability improves or the BoE turns unexpectedly hawkish, the pound may struggle to regain momentum – particularly against the euro, where policy divergence is no longer widening but political contrast is growing.