Morgan Stanley expects the performance of the British pound to weaken over the coming year, as the Bank of England prepares to begin a deeper rate cutting cycle, which may erode the yield advantage that supported the currency throughout 2025.
The bank believes the pound could continue to rise in the first quarter, benefiting from a weaker dollar and maintaining a relatively attractive yield. However, it expects the trend to shift later as economic data increasingly pushes markets to price in a more accommodative monetary policy in the UK.
Morgan Stanley notes that the pound outperformed bearish expectations this year because its yield remained sufficiently attractive to draw capital inflows without raising fiscal concerns. The bank’s model also shows that the combination of yield and volatility helped support the currency despite expectations of rate cuts.
The bank predicts investors will become more accepting of a rate cut toward 2.75%, which could reduce the pound’s appeal and place it among the weaker performers in its tracked indexes. While GBP/USD may briefly rise toward 1.36, Morgan Stanley believes the pound is likely to underperform against risk sensitive currencies and move in a similar direction to the euro.
The bank does not expect the pound to turn into a funding currency, but it may lose enough appeal to discourage some investors. Economic growth or yield could become the main driver of currency movements in the coming period: an improvement in growth or easing financial risks could support the pound, while renewed fiscal risks or rate cuts closer to 2% could place additional pressure on the currency.
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