The British pound’s strong run is likely nearing its end, with Morgan Stanley expecting sterling to lose momentum next year as the Bank of England shifts toward a more aggressive easing cycle and the currency’s carry appeal diminishes.

In its 2026 outlook, the bank says it remains constructive on GBP/USD through early next year, anticipating that broad U.S. dollar softness and still-favorable carry dynamics will keep the pair supported in the first quarter. Beyond that point, however, Morgan Stanley expects the backdrop to weaken as incoming economic data prompt markets to price in a notably more dovish policy trajectory.

The firm highlights that sterling has consistently outperformed expectations in 2025, defying a broadly bearish consensus thanks to a carry profile strong enough to attract inflows without sparking renewed fiscal anxiety.

According to Morgan Stanley, its “Sterling Scowl” framework shows that the mix of elevated carry and relatively contained volatility has provided a solid cushion for the currency—even as investors debated whether the BoE would embark on a deep rate-cutting cycle. The bank now argues that this hesitation will fade in 2026 as disinflation gains traction, labor market slack expands, and fiscal support fades.

Economists at the firm expect investors to become more comfortable pricing Bank Rate down toward 2.75%, a move that would erode the pound’s carry advantage and drag sterling toward the weaker end of the Sterling Scowl diagram.

Morgan Stanley still projects GBP/USD could briefly touch 1.36 in the near term if the dollar softens further, but it expects the pound to underperform more growth-sensitive currencies and track the euro lower as global carry dynamics evolve. While sterling’s carry likely won’t fall enough for it to become a funding currency, the bank notes it may lose sufficient appeal to drop off investors’ preferred-buy lists.

Whether growth or interest-rate carry becomes the dominant driver will be key. Stronger U.K. economic performance next year could help offset downside pressure—especially if fiscal risks subside—while productivity improvements and advances tied to artificial intelligence offer additional upside potential.

On the other hand, Morgan Stanley cautions that sterling could face renewed pressure if fiscal concerns re-emerge or if the BoE adopts an even steeper easing path, with rate cuts toward 2% viewed as particularly negative for the pound.

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