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Demand for UK assets is strong at the start of the new year as the FTSE 100 hits a new record at 10052.
“The FTSE 100’s brief rally above the 10,000 milestone is a powerful signal for UK markets, reflecting ongoing confidence in earnings resilience, attractive valuations and the growing appeal of UK equities to international investors at a time when policy headwinds are beginning to ease,” says Axel Rudolph, Senior Technical Analyst at IG.
Gains for the index have not translated into a similar outperformance by the British pound, which is seeing a mixed performance as 2026 gets underway.
📈 The pound to euro exchange rate trades at 1.1470, a level which it has kept close contact with since Christmas ushered in lower FX turnover volumes.
📉 The pound to dollar exchange rate eases back to 1.3434, having been as high as 1.3530 ahead of New Year’s Eve.
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Gains for the UK’s main stock index are nevertheless indicative of constructive background conditions that could allow GBP/EUR and GBP/USD to resume their respective recoveries when volumes pick up through next week.
GBP/EUR and GBP/USD have a positive ‘high beta’ to stock market sentiment, meaning that they should melt up if stocks continue to rise, all else equal.
Above: The FTSE 100 hits a new record in new year trade.
Rudolph says while the FTSE 100’s recent outperformance may become choppier in 2026, it remains fundamentally supported by globally diversified earnings, strong cash generation and the prospect of a more accommodative Bank of England.
The Bank of England is expected to lower interest rates again in the first quarter of 2026 as it responds to signs of increasing domestic unemployment.
Those rate cuts should help businesses and households, although they should prove a headwind to the pound.
“Softness building in both the UK labour market and inflation data should erode the GBP’s interest rate buffer,” says Paul Mackel, head of FX research at HSBC.
Above: GBP/EUR is constrained by the 100-day moving average. A break above here opens up a quick move to 1.15.
Lower rates at the Bank of England will pressure the UK’s short-dated bond yields lower, and bond yields matter greatly for the pound. This is because international investors chase high yields in their hunt for returns, and the pound has benefited from the UK’s elevated bond yields for a number of years now.
By lowering interest rates, the Bank of England will lower UK bond yields, diminishing their relative attractiveness, which in turn reduces demand for the pound by international investors.
This is why the consensus is generally ‘bearish’ on the pound’s prospects against a number of currencies in 2026.
However, the UK’s inflation rate remains elevated and there is a risk that it stays stubbornly elevated next year.
Above: GBP/USD is pulling back from recent highs, short-term uptrend still intact.
In such a scenario, the Bank won’t be able to lower rates by too much, ensuring the pound’s interest rate advantage remains intact, potentially allowing the currency to outperform consensus this year.
Another upside surprise scenario for sterling would be an economy that pushes through some decent rates of growth, ensuring the rise in unemployment stalls out.
However, for this to happen, government policymaking must take a turn in a more business-friendly direction. It’s on the policy front where we have seen a great deal of uncertainty over the past year, which has hurt business and consumer confidence.
If the Chancellor and Prime Minister can simply keep a steady hand on the tiller this year and not try to do too much, we could see the economy outperform expectations, which will naturally translate into GBP outperformance.
