The Pound Under Pressure: Why UK Inflation, Weak Growth & Fiscal Risks Keep Sterling Vulnerable

The British pound
has entered another challenging phase. Once the standout performer in the G10, sterling is now lagging as the UK economy slows, inflation stays stubbornly high, and fiscal concerns weigh heavily on investor confidence.

Recent updates from the OECD have only reinforced these worries. The organisation raised its UK inflation forecast to 3.5% for 2025, still the second-highest in the G7, before easing to 2.7% in 2026. At the same time, it downgraded UK GDP growth to just 1.0% in 2026. For markets, this combination of sticky inflation and sluggish growth points to an uncomfortable truth: the pound faces structural headwinds that will not disappear quickly.

The Organisation for Economic Co-operation and Development (OECD) is an international body of 38 advanced economies, including the UK, US, Japan, and EU members. It publishes economic forecasts and policy advice that investors and governments treat as key benchmarks.

So when the OECD warns that the UK will have the slowest growth and the highest inflation in the G7, it matters. It tells markets that Britain is underperforming its peers, which investors then factor into their currency strategies.

UK inflation is not just high by accident, it is being driven by specific policy and structural factors:

Together, these factors create a uniquely policy-driven inflation mix that distinguishes the UK from its peers.

Normally, high inflation would force the Bank of England (BoE) into sharp rate hikes, which could strengthen sterling by offering higher yields. But the problem is the type of inflation. This is cost-push inflation from taxes, wages, and imports, not healthy demand.

The BoE cannot cut rates aggressively like the Fed or ECB because inflation is still running hot. Yet keeping rates high risks choking growth further. This stagflation trap undermines investor confidence in sterling.

The Bank’s September decision reflected this balancing act. Rates were held at 4% in a 7–2 vote, with two members already pushing for cuts. Quantitative tightening was slowed to £70bn. For recent analysis of GBP performance following this decision, see our latest weekly FX outlook. Markets now expect another cut before the end of 2025, but the pace will be slower than peers.

If monetary policy is stuck, the November Budget becomes even more critical. Chancellor Rachel Reeves faces a £30bn deficit gap. Economists warn that plugging this hole with more tax rises would further increase business costs and entrench inflation.

Past budgets have already shown this risk. Increases in employer NICs and the minimum wage added to inflationary pressures, while public sector pay awards above inflation boosted government spending.

Business groups such as the CBI are urging the government to pivot. Firms want relief on costs and regulatory burdens, alongside a credible plan to control spending. Without that, investment and hiring will continue to stall, keeping sterling on the back foot.

Markets will scrutinise November’s Budget closely. Any hint of fiscal slippage or inflationary policy could reignite fears of a “mini-Budget” style reaction, where gilts and sterling sell off together.

The OECD expects UK GDP growth of just 1.0% in 2026. That is barely enough to sustain population growth, let alone improve living standards.

The downgrade reflects rising costs of doing business in the UK: higher taxes on employment, uncertainty around fiscal policy, and weak productivity. The September PMI survey confirmed this slowdown, with the composite reading falling to 51 from 53.5 in August, signalling a loss of momentum. For detailed analysis of how the PMI miss impacted sterling, see our market reaction coverage.

For sterling, weak growth means fewer capital inflows and less confidence. The pound’s underperformance compared with peers is already clear:

Unless the UK delivers pro-growth reforms, the pound will continue to struggle relative to peers.

Sterling’s weakness is most visible against the euro. GBP/EUR fell to 1.1438, its lowest in two months, after UK PMIs disappointed while Eurozone data improved.

Strategists at Brown Brothers Harriman argue that relative economic momentum now favours the euro. UBS analysts warn that GBP/EUR risks drifting below the 1.1413 summer low in the coming weeks, with a medium-term target around 1.1363 by 2026.

Fiscal concerns amplify this pressure. Long-dated gilt yields have surged to their highest levels since the late 1990s, reflecting investor unease. If the November Budget relies too heavily on tax hikes, GBP/EUR could fall further as businesses and investors hedge against UK underperformance.

Sterling’s performance against the dollar looks better, but the optics are misleading. GBP/USD has hovered around 1.35, supported largely by Fed easing expectations rather than UK strength.

The Fed cut rates last week and signalled more cuts in late 2025, reducing the dollar’s yield advantage. That has allowed GBP/USD to hold ground. But relative to other European currencies, sterling is still lagging.

If UK data continues to weaken and fiscal risks rise, GBP/USD could struggle to sustain gains even if the dollar softens. The real risk is that once Fed easing is fully priced in, attention shifts back to the UK’s domestic vulnerabilities.

The UK now faces a toxic mix: sticky inflation, weak growth, and fiscal uncertainty. Each factor on its own would weigh on sterling, but combined they create a structural headwind that investors cannot ignore.

Even if higher rates offer short-term support, the bigger picture points to relative underperformance. Unless the government delivers bold pro-growth, confidence-restoring reforms in November, sterling will remain vulnerable.

The pound’s trajectory is no longer about short-term data surprises. It is about a deeper story: the UK has become trapped in a cycle of high inflation, weak growth, and fiscal risk.

The OECD’s forecasts have crystallised this picture, warning of the highest inflation in the G7 and the slowest growth among major economies. Investors are responding by pushing GBP/EUR lower, holding GBP/USD steady only because of dollar weakness, and demanding higher yields on gilts.

For sterling to recover, the UK needs more than monetary policy. It needs a credible fiscal plan that tackles costs, supports growth, and restores confidence. Without it, the pound will remain one of the most vulnerable currencies in the developed world. For businesses managing GBP exposure during this volatile period, our comprehensive forward contracts guide explains protection strategies.