Sterling is forecast to remain under significant pressure until at least May, with economists pointing to persistent doubts over Sir Keir Starmer's leadership as a key factor spooking investors.
Political Uncertainty Weighs on Currency
Analysts at the investment bank Investec have warned that the pound's potential for further strengthening is being held back by continued questions over Starmer's authority within the Labour Party. In a preview of the UK's economic year, Investec economist Ellie Henderson cautioned that a "fairly resilient backdrop" for the economy could be undone by political chaos in Westminster following crucial local elections in May.
Henderson stated that forecasters had "pencilled in an element of sterling weakness" for the first half of 2026, driven by the risk of the current Labour government fracturing if it suffers dire results at the ballot box. "There's a lot of talk that if this does go badly for Labour, then that could be the final nail in the coffin for Starmer as Prime Minister of this country," she said.
Labour Faces Critical Local Election Test
The political pressure on Starmer is intensifying ahead of local elections expected in May. Votes are due across 32 London borough councils, as well as in major cities including Birmingham, Newcastle, and Manchester. The Labour Party is under intense pressure to defend hundreds of seats.
National polling paints a grim picture for the governing party. A recent YouGov survey shows Labour now trails the Reform party by as much as nine points and has fallen behind the Conservatives for the first time since the 2024 general election. Reports suggest cabinet ministers, including Wes Streeting, are considering challenging Starmer's leadership to change the party's fortunes.
City Analysts Rate Potential Successors
The financial markets are already assessing the implications of a potential leadership change. A note from American bank Jefferies this week indicated that Angela Rayner's possible rise to Downing Street is a top concern for UK banks. However, analysts Jonathan Pierce and Priya Rathod suggested a potential partnership of Wes Streeting as Prime Minister and Pat McFadden as Chancellor "could be viewed positively by the market."
Beyond politics, Investec's Henderson offered a more positive economic outlook. She predicts UK growth of 1.3 per cent in 2026, slightly below the Office for Budget Responsibility forecast but above the OECD's. She also forecasts inflation could drop to the Bank of England's 2 per cent target, with interest rates potentially falling to 3.25 per cent, implying two rate cuts this year.
"If there's a boost in confidence and consumers save less of their income each month and spend it instead, this could unleash a lot more momentum into the economy," Henderson added, also citing potential gains from government housebuilding pledges.
For the currency, the hope is that stability will return after May. Henderson concluded: "With this political uncertainty, we imagine investors will have a bit of caution around sterling in the first half of the year... we hope to see sterling float between a stronger euro and a weaker dollar by the end of 2026." This follows a year in 2025 where the pound strengthened against the US dollar but weakened against the euro.
