BNP Paribas strategists have issued a cautious outlook for the British pound and the UK economy, forecasting that UK economic growth will slow to 1% in 2026 from an estimated 1.3% in 2025, while inflation is projected to rise to 3.2% as renewed price pressures emerge from the ongoing war in Iran.

Slower Growth and Renewed Inflation Pressures

The French banking group’s analysis points to a dual challenge for the UK economy: weaker gross domestic product (GDP) expansion alongside a notable increase in consumer prices. The projected 3.2% inflation rate for 2026 would represent a significant rise from current levels, according to the source, with the increase driven mainly by disruptions to global energy markets and supply chains linked to the conflict in the Middle East.

BNP Paribas strategists said the war in Iran is adding new cost-push pressures to the UK economy, particularly through higher energy and commodity prices. For an energy-importing economy such as the UK, increases in global oil and gas costs can feed into household bills, transport costs, and business operating expenses, making inflation harder to bring back toward the Bank of England’s target. Such an external shock is expected to make the Bank of England’s (BoE) monetary policy path more difficult, as policymakers weigh the need to contain inflation against the risk of weakening economic activity further.

Implications for the Pound and Interest Rates

The combination of slower growth and higher inflation presents a stagflationary scenario for the UK, a backdrop that has historically been negative for the British pound. However, BNP Paribas noted that the BoE may be forced to maintain or even raise interest rates in response to elevated inflation, a development that could provide some short-term support for the currency.

“The market is likely to price in a more hawkish BoE, which could limit the pound’s downside against currencies like the euro and the US dollar,” the strategists said in a note. “However, the deteriorating growth outlook will cap any significant appreciation.”

The forecast suggests UK interest rates could remain higher for longer than previously expected if the central bank continues to prioritize inflation control over support for growth. That would have direct consequences for mortgage holders, businesses, and government borrowing costs, while also shaping expectations in currency markets as traders assess how persistent inflation pressures may affect the BoE’s policy stance.

Wider Economic Context

BNP Paribas’s projections come during a period of heightened geopolitical uncertainty. The war in Iran has already contributed to volatility in global oil markets, with Brent crude prices moving sharply. For the UK, which is a net importer of energy, higher global energy costs translate directly into increased household bills and higher operating expenses for businesses.

The bank’s 1% growth forecast for 2026 would mark the weakest expansion for the UK economy since the pandemic-era contraction in 2020, excluding the brief technical recession in late 2023. The outlook highlights the fragility of the UK’s economic recovery and the continuing challenges posed by external shocks.

BNP Paribas’s analysis describes a difficult environment for the British pound and the broader UK economy, shaped by slower growth and rising inflation. The forecast also underscores the trade-offs facing the Bank of England as it navigates a stagflationary setting influenced by geopolitical conflict. In the months ahead, the key indicators for assessing that trade-off will include energy prices, supply-chain conditions, UK inflation data, and signals from BoE policymakers on whether inflation control continues to take priority over support for growth.