HSBC examines the impact of the Bank of England’s recent interest rate cut on the British pound. The report suggests that the BoE’s easing cycle might result in the GBP lagging behind other currencies like the AUD and NZD, which are expected to experience rate hikes.
The BoE reduced its policy rate by 25 basis points to 3.75% on 18 December, marking the sixth reduction in the current easing cycle. Despite the cut, the meeting had a hawkish tone, with guidance indicating future policy easings could be more debated.
Expectations for Further Rate Reductions
With expectations for continued rate reductions in 2026, the GBP is likely to underperform against other G10 currencies. These currencies, such as the AUD and NZD, already have neutral policy rates or are anticipated to see rises.
We saw the Bank of England cut its policy rate last week to 3.75%, the sixth reduction in this cycle. This action creates a clear divergence against other central banks like those in Australia and New Zealand. Their policies are expected to get tighter, not looser.
This policy difference is rooted in recent economic data, which gives us confidence in the trend. The UK’s latest inflation reading for November 2025 slowed to 2.1%, justifying the BoE’s cuts, while third-quarter inflation in Australia and New Zealand remained stubbornly high above 4.5%.
Given this outlook, we believe positioning for further Sterling weakness against the Aussie and Kiwi dollars is a primary strategy. This could involve selling GBP/AUD and GBP/NZD futures contracts. The widening interest rate differential should continue to pressure these currency pairs lower into the new year.
Historical Model of Policy Divergence
We’ve seen similar patterns in the past, such as the strong US dollar trend from 2014 to 2016 when the Federal Reserve signaled tightening while the ECB and Bank of Japan were easing. That period of policy divergence provides a historical model for what could happen with the Pound now. Such trends can be powerful and last for many months.
The BoE’s comment that future easing is a “closer call” introduces some uncertainty, which we must manage. For options traders, this means implied volatility on GBP pairs may remain elevated, making strategies like buying puts on the pound potentially expensive but effective. This uncertainty will be a key factor to watch heading into the January 2026 meeting.
In the immediate next one to two weeks, we should be mindful of thinning liquidity due to the Christmas and New Year holidays. While the underlying bearish trend for the pound is clear, low trading volumes can sometimes lead to sharp, unpredictable price moves. Normal market conditions will likely resume in early January, providing a clearer environment to act.
