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Strong UK growth brings a December Bank of England rate rise closer and supports the pound against the euro, although a faster-moving Federal Reserve means the dollar sets the pace until US inflation cools.
The pound is tipped to extend its advantage over the euro after the UK economy posted its strongest quarter of 2026, although investment bank analysts say the dollar will keep the upper hand while Federal Reserve rate hike expectations are rising.
The economy grew 0.7% in the third quarter, up from 0.5% in the second, with business-facing services leading, household consumption up 0.6% and business investment up 0.4%, the Office for National Statistics said on Thursday.
The figures matter for the pound because the Bank of England raised Bank Rate to 4.00% last week and said a further increase may be warranted unless other developments soften inflation pressures.
A faster-growing economy gives the Monetary Policy Committee less reason to wait, and analysts say the question is now whether the next rise comes in December or February.
Money markets price 18 basis points of tightening for the December meeting, up from 13 a week earlier, after Deputy Governor Clare Lombardelli said this week she would not rule out a move at that meeting.
Growth over the first three quarters of the year stands at 1.8%, the best start to a year since the pandemic rebound, and Deutsche Bank says it will again raise its above-consensus forecast for 2026, "productivity growth looks to be turning a corner. Output per worker has been rising across the economy speaking to a more resilient upswing in GDP momentum," says Sanjay Raja, Chief UK Economist at Deutsche Bank.
Raja estimates AI-related spending added 0.3 to 0.4 percentage points to growth this year, which is the investment channel Pound Sterling Live reported on when the data landed.
Analysts Split on Whether the Data Brings December Into Play
"Today's figures, at the margin, make a December hike more likely," says a note from Pantheon Macroeconomics, which forecasts rises in February and April and is "close to bringing those forward to December and February."
"Resilient UK economic activity reinforces the case for additional BOE hikes which is GBP positive, especially against EUR," says a note from Brown Brothers Harriman, which reports swaps imply around a 70% chance of a December rise.
A December move would take Bank Rate above the 2% to 4% range the Bank estimates as neutral, and Brown Brothers Harriman warns that raises the risk of a sharper growth slowdown ahead.
However, the Monetary Policy Committee projected 0.7% growth for the quarter in last week's forecasts, and MUFG says the print therefore changes little, "policymakers will remain focused on underlying inflation pressures," says a note from MUFG, which expects one further rise to 4.25% in February rather than December.
"Inflation remains more decisive for the immediate policy outlook, but another strong quarter gives policymakers somewhat more room to respond if price pressures remain persistent," says Lloyds.
ING also expects the next rise in February, "the strength in GDP this year is evidently beginning to play a bigger role in its decision-making," says a note from ING, which attributes much of the quarter's growth to data centre investment and AI-related activity and expects household spending to weaken as utility bills rise by around 25% in January.
The Dutch bank goes further than the rest of the field in expecting the Bank to be cutting again within a year, "if we're right that inflation starts to look less problematic by next summer, we think the Bank is likely to return to rate cuts before the end of 2027 – or early 2028 at the latest," it adds.
The Dollar Sets the Pace for the Pound-to-Dollar Rate
Price action shows where the growth story helps the pound and where it does not: the pound-to-euro exchange rate is at 1.1965, while the pound-to-dollar exchange rate is at 1.3235 after falling to 1.3223 on Thursday, through October's low.
The dollar has risen to an 18-month high since Tuesday's hotter-than-expected US inflation figures, which left markets debating whether the Federal Reserve raises rates by 25 or 50 basis points in December, as Pound Sterling Live has reported.
"While the data supports the graduated uptick in December MPC pricing the contrast with immediate Fed pricing suggests that despite the improved data trend we can expect GBP/USD to struggle to close above 1.3273, in line with the 28 October low," says a note from CIBC.
"The sharp drop over the past few days appears to be overstretched but with no signs of stabilisation yet, GBP could test 1.3200," says Quek Ser Leang, Senior Technical Strategist at UOB, who says a continued decline below that level is unlikely.
Brown Brothers Harriman says the dollar has overshot the level implied by rate differentials and that stagnant US real wages will constrain the pricing of a 50 basis point Federal Reserve rise, which limits the scope for further dollar gains near term.
A dollar that is rising against the pound and the euro alike leaves the pound-to-euro rate as the pair that reflects the UK growth story, and J.P. Morgan's strategists hold a short EUR/GBP position targeting 0.82 (GBP/EUR to 1.2195) on the grounds that supportive UK politics, Bank of England policy, UK growth and sterling's carry can push the pair two pence below their 0.8460 fair value estimate.
Pound Sterling Live continues to hold a constructive medium-term view on the pound against the euro; the economy is outperforming the forecasts made at the start of the year, business investment is rising and the euro is undermined by French fiscal stress.
For the pound to turn higher against the dollar, US inflation must cool enough for markets to pare their Federal Reserve pricing, and until it does the UK's growth story will show up against the euro rather than the dollar.
