Sterling's path to 1.40: plausible scenario or wishful thinking?

​​​Central bank divergence is the critical variable

​The case for a stronger British pound rests primarily on central bank divergence, with markets pricing a more aggressive Federal Reserve(Fed) easing cycle than Bank of England (BoE) cuts. If that plays out, sterling could push through 1.35 and target 1.38-1.40 over the coming year.

​The Fed's trajectory is critical. If US unemployment rises on AI-related displacement and the Fed front-loads easing, the US dollar risk premium narrows sharply. But the question is whether the Fed can engineer a soft landing or whether it ends up cutting too late, triggering a harder downturn that supports the dollar through haven flows.

​The Bank of England (BoE) faces its own dilemma. UK growth remains subdued, but services inflation is proving stickier than hoped. If the BoE accelerates easing due to growth weakness while inflation stays elevated, sterling struggles regardless of what the Fed does. The bank needs inflation to cooperate if it's going to maintain a measured pace that supports the currency.

​Fiscal credibility and political stability matter

​Fiscal credibility matters more for sterling than the market currently appreciates. Post-election budget plans will be scrutinised for evidence that the government can consolidate without strangling growth. Credible fiscal signals could tighten gilt spreads and provide underlying support for the pound.

​The UK's challenge is smaller in scale than the US deficit problem, which creates an opening. US deficit concerns are larger and more intractable, and renewed focus on Treasury supply could weigh on the dollar if bond vigilantes resurface. If the UK demonstrates better fiscal management than the US – admittedly a low bar – sterling could benefit from a relative credibility premium.

​UK political stability following the 2025 election could remove part of sterling's discount. The UK has carried a political risk premium since Brexit, and a period of stable government could narrow that meaningfully. US politics into the 2026 mid-cycle pose their own risks, especially around trade or tech policy shocks that raise dollar volatility.

​Growth and inflation create competing pressures

​Growth divergence cuts both ways. UK productivity has been dismal for years, but any upside surprise from investment would lift sterling. The bar is low, which means pleasant surprises are possible. US activity will hinge on how deep the Federal Reserve's (Fed) easing cycle goes – a shallow cycle would keep the dollar supported.

​If UK services inflation proves stickier than US inflation, sterling stays capped. Faster US disinflation would increase the likelihood of multiple Fed cuts and lessen dollar strength.

​Risk appetite and the AI theme

​Risk appetite provides another lens. A global risk-on environment driven by AI-led capex and tech earnings tends to weaken the dollar and lift pro-cyclical currencies like sterling. But any correction in tech valuations or jump in volatility would quickly reverse those flows.

​Sterling benefits when investors are optimistic about global growth. A sustained period of risk-on sentiment would support the pound even if other factors remain neutral. The challenge is that risk appetite can shift quickly, often with little warning.

​Base case and what could go wrong

​The base case for mild sterling appreciation is plausible if the Fed cuts more quickly than the BoE and UK fiscal signals improve. This requires central bank divergence to play out as currently priced and for UK politics to stabilise post-election.

​But it's a narrow path. The Fed needs to cut aggressively without signalling panic. The BoE needs inflation to cooperate. UK fiscal policy needs to be credible but not excessively tight. And global risk appetite needs to remain constructive.

​The main risk is a deeper UK slowdown that forces the BoE to cut more aggressively, or a shorter, shallower US easing cycle. Either scenario would undermine the divergence trade that underpins sterling strength.

​GBP/USD – technical analysis

​Sterling has enjoyed a steady recovery from November’s lows at $1.30, and has regained the $1.32 level, which had marked the lows in May and August. The early September low at $1.33 is now being fought over, but a close above here helps to reinforce the bullish view.

​Beyond this lies the September high at $1.37, and then on the July high at $1.38.

​The weekly chart shows a continued recovery from the 2022 lows, with a series of higher highs and higher lows, leaving a bullish case intact for the time being. 

​GBP/USD weekly candlestick chart

GBP/USD daily candlestick chart