Sterling extended gains versus the dollar through the first week of 2026 as traders positioned for a more hawkish Bank of England policy trajectory while simultaneously pricing in aggressive Federal Reserve rate cuts later this year. The divergence in central bank expectations has created fresh momentum for GBP/USD, with institutional investors rebuilding long positions after year-end rebalancing, according to market participants.
The shift in sentiment follows stronger-than-expected UK inflation data released in late December and hawkish commentary from BoE officials emphasizing inflation persistence above the 2% target. Strategists at major banks note that money markets now price in an additional 75 basis points of BoE tightening by mid-2026, compared to just 50 basis points at the end of November. Meanwhile, Fed fund futures suggest the US central bank will cut rates by 100 basis points in the second half of the year as inflation concerns ease and labor market conditions soften.
Technical analysts highlight that GBP/USD has broken above a key descending trendline that constrained price action through the final quarter of 2025, triggering algorithmic buying programs and forcing short-covering from hedge funds. The move has also lifted other sterling crosses, with EUR/GBP retreating as the pound outperforms even the resilient euro. Commodity currencies are benefiting from the dollar's broad-based weakness, though traders caution that volatility may increase as central bank meetings approach later this month.
Looking ahead, market participants are closely watching next week's UK employment and wage data, which could further fuel BoE tightening bets if wage growth remains elevated. In the US, the December CPI report will be critical for validating Fed easing expectations. "The divergence trade is crowded but not yet exhausted," said a senior currency strategist at a London-based trading firm. "Sterling has room to run if UK data continues to surprise to the upside while US indicators confirm a cooling economy."
Disclaimer: This analysis is AI-generated for educational purposes. Traders should verify all information and conduct their own research before making trading decisions.