Sterling will suffer from speculation over Keir Starmer’s leadership until at least the May elections, economists have predicted, with 2026 tipped to become another year where Westminster infighting sparks City jitters.
Analysts at Investec have suggested that the further strengthening of the pound will be held back by continued questions over Starmer’s authority across the Labour Party.
In a preview of the UK economy over the upcoming year, Investec’s Ellie Henderson warned that a “fairly resilient backdrop” for the economy could be undone by chaos in SW1 after crucial local elections in May.
Henderson said forecasters at the City firm had “pencilled in an element of sterling weakness” due to the potential for the current Labour government to break up over dire election results.
Labour under pressure at local elections
Among the local authorities expected to hold elections are 32 London borough councils, plus seats across the likes of Birmingham, Newcastle and Manchester.
Labour is under intense pressure to defend hundreds of seats. In national polling by YouGov, the party now trails Reform by as much as nine points and has now fallen behind the Tories for the first time since the 2024 general election.
Reports have also suggested that Wes Streeting and other cabinet ministers are hoping to challenge Starmer to change the party’s fortunes.
Henderson said: “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 Stamer as Prime Minister of this country.
“With this political uncertainty, we imagine investors will have a bit of caution around sterling in the first half of the year, but hopefully as the May local elections pass and that certain uncertainty fades, then we hope to see sterling float between a stronger euro on the one hand and a weaker dollar on the other hand by the end of 2026, which also reflects expected changes in interest rates across the jurisdictions.”
The pound became stronger against the US dollar over the course of 2025 and weaker against the euro.
Starmer’s possible successors rated by City
A note from the American bank Jefferies this week warned that Angela Rayner’s possible rise to Downing Street topped the list of concerns for banks in the UK.
“Bank holders may be particularly concerned by certain potential combinations,” said equity analysts Jonathan Pierce and Priya Rathod.
But analysts at the bank also said the probability of a Wes Streeting-Pat McFadden partnership in No 10 and No 11 respectively “could be viewed positively by the market”.
Bond traders are also watching out for any surprises in Westminster, with leaked Budget plans last year sending gilt markets into a frenzy.
Beyond the threat of politics to markets, Henderson struck a more positive tone on the upcoming economic outlook.
The investment management firm’s UK economist predicts growth to hit 1.3 per cent this year, slightly below the Office for Budget Responsibility (OBR)’s forecast but above several major forecasters including the OECD.
Henderson also said inflation could drop to 2 per cent this year.
Analysts also took a more dovish line on its borrowing costs prediction by suggesting interest rates could fall to 3.25 per cent, meaning there could be two 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.
“We also need to think about the government’s plans. They’ve made a big pledge to boost house building. If this starts to bear fruit, then this could also unlock faster economic growth.”