What happened in January?
After making significant gains against the dollar last year, and outmuscling the pound, the euro continued to make gains in the first month of 2026.
Euro quick out of the blocks
The euro hit its highest point against the dollar since 2021 towards the end of January, as investors reacted to a new EU-India trade deal and President Trump’s retraction of threatened tariffs over the Greenland standoff. The EU currency continues to benefit from the bloc’s low inflation – down to 2.3% in December – and settled monetary policy.
The pound reacts to mixed signals
The pound also enjoyed a buoyant start to 2026, climbing over 1.9% against the dollar in the past month. Nevertheless, the UK economy is offering mixed signals. Worries over inflationary pressures may limit the Bank of England’s (BoE) scope to lower interest rates again in the near term, after a cut to 3.75% in December. Interest rates directly impact exchange rates by making currencies more or less attractive to investors.
The dollar weakens
The dollar struggled in January due to President Trump’s persistent tariff threats, concerns about the independence of the US Federal Reserve (Fed) and the likelihood that a more dovish Fed chairman – most likely Kevin Warsh, an outspoken critic of the central bank – will take office in May. While interest rates were kept unchanged in January, investors are looking at the possibility of faster, deeper cuts in the second half of the year.
What’s in store for February?
The pound
While the threat of US tariffs on UK goods over Europe’s support for Greenland has receded, the possibility has not gone away. Money markets will be looking at the progress of any talks over the territory to judge the mood in the White House. A further tariff on UK imports to the US would undermine economic growth and potentially weaken the pound, which is not considered a safe haven currency.
Investors will also be looking at UK inflation data closely. The British Retail Consortium reported significant upwards price pressures in January. Were that to continue, the BoE would likely choose to keep interest rates unchanged for at least another month. The pound may benefit if investors judge that interest rates are likely to stay higher for longer.
The euro
The euro’s strength has been a common theme over the last year and that is likely to continue for the foreseeable future. The European Central Bank’s (ECB) monetary easing cycle appears to be over for now, with interest rates sitting at a comfortable 2.15%, well below rates in the UK and US (both 3.75%). Markets currently see only the modest possibility of a further rate cut in the summer.
The euro will be supported this month by a continuing – if gradual – recovery in growth in the eurozone. Consumer sentiment is slowly turning positive in major EU economies like Germany, and business activity is enjoying a modest upturn. The latest economic data is mixed, but generally aligns with predictions of 1.3% growth in the bloc in 2026. Risks this month include a deterioration in the EU’s relationship with Washington and a return to the threat of a transatlantic trade war.
The dollar
The dollar’s volatility has been a feature of exchange rates recently and that may be set to continue. The dollar fell to its lowest level in four years towards the end of January before rallying slightly, and has tumbled more than 10% in the last year. The dollar has been impacted by Washington’s return to using tariff threats as a foreign policy weapon, along with President Trump’s suggestion that the administration is happy with a weaker currency.
The dollar’s unpredictability could cause further fluctuations in exchange rates this month. Policy uncertainty and weak consumer confidence are likely to weigh on the currency, and investors will also keenly await any statement from the incoming Fed chair. Warsh is thought likely to drive a dovish monetary policy that is more tightly aligned with White House preference. That in turn could lead to questions over the Fed’s independence, though Warsh is considered a steady hand by peers. Investors could turn away from the dollar if they suspect interest rate cuts are being driven by political rather than fiscal calculations. For now, we expect rates to remain as they are in February.
The takeaway?
The euro and pound are both making gains at the dollar’s expense and that could continue. Much depends on President Trump’s unpredictable approach to policy making. Whatever the details, businesses should be prepared for volatility in exchange rates as the month plays out.
