Analysts forecast the pound to euro and dollar exchange rates to weaken as UK fiscal concerns and excessive Bank of England rate-hike pricing undermine the GBP.
The bank forecasts the Pound-to-Dollar exchange rate at 1.32 by September and 1.31 by the end of 2026, while EUR/GBP is expected to rise to 0.86.
That EUR/GBP forecast equates to a Pound-to-Euro rate of approximately 1.1630, compared with current levels around 1.1702.
GBP/USD was trading near 1.3334 at the latest update, having recovered modestly from July’s low at 1.3221 but remaining more than two cents below the monthly high at 1.3558.
The Pound-to-Euro rate has also retreated from July’s 1.1827 peak, although it remains approximately 0.8% higher for the month and 2.1% stronger since the beginning of the year.
Crédit Agricole says investors have concentrated too heavily on Sterling’s attractive yield and have paid insufficient attention to the fiscal risks embedded in elevated UK government bond yields.
Pound to Dollar (GBP/USD): 1.333972 (+0.11%)
Euro to Dollar (EUR/USD): 1.139589 (+0.22%)
Not All Eyes Should Be on the Bank of England
“For some time now, FX investors have focused almost exclusively on one feature of the GBP – its superior carry appeal which, in turn, reflected the fact that gilt yields remain the highest in G10,” says Valentin Marinov, Head of G10 FX Research and Strategy at Crédit Agricole.
“This has been a very imbalanced view.”
The bank argues that high gilt yields do not simply reflect expectations for Bank of England policy.
They also contain compensation for UK sovereign credit risk, which Crédit Agricole expects to become increasingly important during the opening months of Prime Minister Andy Burnham’s government.
The concern is that proposed cost-of-living measures and other policy commitments could consume the government’s already limited fiscal headroom.
Crédit Agricole identifies removing VAT from energy bills, raising the personal income-tax allowance and increasing military expenditure as examples of policies that could add to the pressure.
The potential use of new revenue-raising measures, including a higher top rate of income tax or a land tax, could create further uncertainty if they weaken business confidence and damage the economic outlook.
“Attempts by the Burnham government to use ‘fiscal flexibility’ to push for off-balance investment projects with limited to no positive growth impact in the near term could rankle gilt vigilantes,” the bank says.
“To the extent that UK sovereign credit risks rise as a result, the GBP should relinquish its recent gains.”
Markets Price Too Much BoE Tightening
The Bank of England meeting will provide the next major test for the Pound.
Crédit Agricole and the market both expect policymakers to leave Bank Rate unchanged at 3.75%, but the bank sees a significant risk that the accompanying guidance disappoints investors expecting further tightening.
UK rate markets were pricing around 65 basis points of BoE increases when the report was produced.
Crédit Agricole describes that outlook as “very hawkish”, particularly given the challenging UK growth backdrop.
“We further think that the MPC could remain non-committal with respect to future hikes, notwithstanding the latest increase in global energy prices,” says Marinov.
“This could deal a blow to the current market rate expectations and thus to the GBP’s relative rate appeal.”
The bank’s own interest-rate forecasts show Bank Rate remaining at 3.75% through the middle of 2027, before falling to 3.50% in September and 3.25% by the end of next year.
That is materially less hawkish than current market pricing and helps explain the bank’s cautious near-term Sterling view.
A reduction in expected BoE tightening would be particularly important because the Pound’s recent resilience has depended heavily on the UK’s yield advantage.
Should markets conclude that the central bank is unwilling to deliver the increases currently priced, Sterling would lose an important pillar of support at the same time that investors are scrutinising the government’s fiscal plans.
Crédit Agricole Targets GBP/USD at 1.31
Crédit Agricole forecasts GBP/USD at 1.32 in September before a further decline to 1.31 in December.
The pair is expected to recover gradually thereafter, reaching 1.32 in March 2027, 1.34 in June, 1.37 in September and 1.39 by the end of next year.
The forecast therefore separates a bearish near-term phase from a more constructive longer-term outlook.
From the latest rate near 1.3334, the September forecast implies a decline of roughly 1%, while the December target would represent a fall of approximately 1.8%.
The immediate downside reference is July’s low at 1.3221.
A move through that level would bring Crédit Agricole’s 1.32 September target into view and strengthen the case for a deeper decline towards 1.31.
On the upside, the recent closes show resistance emerging around 1.3380-1.3430, while the mid-July highs around 1.3540-1.3560 represent the more substantial barrier.
GBP/USD would need to recover through that upper zone to show that the correction from July’s peak has run its course.
The Dollar view is not entirely straightforward.
Crédit Agricole believes current expectations for two additional Federal Reserve rate increases are too hawkish and says softer guidance or data could offer the Dollar limited support in the near term.
The bank also argues that changes in the way foreign investors finance the US current-account deficit may be weakening the Dollar’s traditional safe-haven response during periods of market stress.
Even so, it retains an above-consensus view on the Dollar and describes its GBP/USD outlook as cautious.
The US economy is expected to outperform many European and Asian economies, while persistent inflation and the continued strength of the artificial-intelligence investment cycle should maintain demand for US assets.
Euro Gains May Be More Limited
Crédit Agricole forecasts EUR/GBP at 0.86 in September, December and March 2027.
Converted into GBP/EUR terms, that implies a rate near 1.1630.
The bank then expects EUR/GBP to ease to 0.85 by June 2027 and 0.84 by the end of next year, equivalent to GBP/EUR recovering towards approximately 1.1765 and 1.1905 respectively.
Although the near-term forecast favours the Euro, Crédit Agricole believes some of the negative UK outlook is already reflected in Sterling’s valuation against the single currency.
“We believe, however, that some negatives are already priced into the GBP especially versus the EUR, given that the Eurozone would have to deal with the consequences from the negative oil supply shock in the wake of the Iran war as well.”
The bank also notes that Sterling already looks oversold and that global investors appear underinvested in UK assets.
Those factors may limit the extent of losses against the Euro even as political and fiscal risks remain elevated.
The current Pound-to-Euro rate near 1.1702 is already much closer to Crédit Agricole’s implied 1.1630 target than July’s high at 1.1827.
A break below 1.1690 would expose the 1.1600-1.1630 area, while a recovery above 1.1760 would be needed to improve the near-term picture.
Positioning Offers Some Protection
Crédit Agricole’s positioning data provide one counterweight to its bearish forecast.
The Pound attracted buying interest during the latest reporting week, led primarily by futures-market flows.
Banks, hedge funds and real-money investors were buyers, while corporate accounts sold Sterling.
Despite those inflows, the bank’s broader positioning measure still shows the Pound among the more lightly held G10 currencies and below its medium-term average.
This is consistent with the view that Sterling is already oversold and global investors remain underexposed to UK assets.
Light positioning could limit the speed of further declines or produce a sharper rebound should the BoE sound unexpectedly hawkish or the government provide credible fiscal reassurance.
It does not, however, remove the underlying risk identified by Crédit Agricole: that high gilt yields are increasingly a warning about sovereign risk rather than an uncomplicated source of support for the currency.
Pound Sterling Forecast: Short and Medium Term
Crédit Agricole maintains a bearish view on Sterling against both the Dollar and the Euro from current levels.
Its GBP/USD forecasts point to 1.32 in September and 1.31 in December, while EUR/GBP at 0.86 implies GBP/EUR near 1.1630.
The bank expects the BoE to leave rates unchanged and remain non-committal about further increases, potentially challenging the approximately 65 basis points of tightening priced by investors.
At the same time, Prime Minister Burnham’s fiscal programme could force markets to reassess whether the UK’s high bond yields represent attractive carry or growing sovereign risk.
Some bad news is already reflected in the Pound, particularly against the Euro, and light investor positioning should provide a degree of protection.
Nevertheless, the near-term balance of risk remains negative while GBP/USD trades below 1.3430 and GBP/EUR remains unable to regain the 1.1760 area.
