GBP/USD is trading around 1.3490, down 0.10% on Monday. The currency pair is steady as markets consider the differing rate approaches of the Federal Reserve (Fed) and the Bank of England (BoE) amid lower liquidity during the holiday period.
The Pound shows little support despite expectations of BoE’s gradual monetary easing in 2026. UK inflation, which was 3.2% in November, remains above the 2% target but has eased from its July to September peak of 3.8%. The BoE recently lowered interest rates by 25 basis points to 3.75%, although further cuts appear limited as rates near a neutral level.
Economic Growth and Rate Expectations
The BoE expects near-flat growth as the UK GDP increased by 0.1% in the third quarter. Meanwhile, the US Dollar is slightly rebounding, with expectations for a quicker easing cycle from the Fed next year. The CME FedWatch tool indicates a 70% chance of at least 50 basis points of cumulative rate cuts.
The Fed’s projections suggest limited cuts by 2026 with the Federal Funds Rate around 3.4%, contrasting with market expectations. Speculation on US monetary policy has increased due to President Trump’s comments favouring lower rates, with attention now on the upcoming FOMC Minutes release.
The percentage changes of the British Pound against various currencies show it was strongest against the New Zealand Dollar.
Diverging Monetary Policies
As we head into the new year, the primary focus is on the diverging paths of the Bank of England and the Federal Reserve. With GBP/USD consolidating around 1.3490 in thin holiday trading, this divergence will likely create opportunities in the coming weeks. The key is to position for a potentially stronger pound against a dollar weighed down by expectations of faster rate cuts.
The Bank of England’s caution is justified by inflation that, while easing to 3.2%, remains stubbornly above target. We remember the inflation shock of 2022-2023, and that memory is forcing the BoE to be gradual, as shown by their recent narrow five-to-four vote to cut rates. This slow pace of easing should provide underlying support for the pound, especially as UK wage growth, last reported by the ONS at 5.7%, continues to add to domestic price pressures.
Conversely, the market is aggressively pricing in Fed rate cuts for 2026, anticipating at least 50 basis points of easing. This sentiment persists despite the Fed’s own projections suggesting a much shallower cutting cycle. This tension between market expectation and official guidance is a weak point for the dollar, especially after we saw US Core PCE, the Fed’s preferred inflation gauge, fall to an annual rate of 2.8% in November 2025, giving doves more ammunition.
Given this setup, we should consider strategies that benefit from potential GBP strength against the USD. Buying GBP/USD call options or call spreads for late January or February 2026 could be an effective way to play a potential breakout above 1.3500 with defined risk. Implied volatility may be relatively low during this holiday period, making options an attractive tool before the first major data releases of the new year.
The immediate catalyst will be the FOMC minutes released this Tuesday, which will be scrutinized for any signs of a dovish shift among policymakers. We should look for any discussion that validates the market’s aggressive rate-cut pricing over the Fed’s official dot plot. Following that, the first US and UK inflation reports in mid-January will be critical in either confirming or challenging the current policy divergence narrative.
