GBP/EUR back above 1.17 as European bond stress hits the euro

Market overview

FX markets saw a meaningful shift in momentum yesterday, with GBP/EUR back trading above 1.17 as sterling benefited from attractive UK yields and renewed pressure on the single currency. The euro was the clear underperformer as concerns around French government debt intensified, while the dollar remained relatively firm and the Swiss franc attracted defensive demand. Across the wider market, attention has shifted back towards interest-rate expectations and the growing divergence between the US, UK and euro area.

Bond markets remain at the heart of the move. French borrowing costs have risen sharply, increasing concerns over the country's fiscal outlook and putting additional pressure on European assets. At the same time, expectations for an immediate Federal Reserve rate rise have eased following more cautious comments from policymakers. With US payrolls due today, traders now have another major catalyst that could set the direction for the dollar into the weekend.

USD: Payrolls in focus as Fed expectations cool

The dollar remains well supported despite a noticeable reduction in expectations for an October Federal Reserve rate rise.

Comments from Fed officials have encouraged markets to consider a more patient policy path, with pricing for an October move falling sharply compared with levels seen only a week ago. Investors are increasingly looking towards December as the more likely window for another rate increase.

Attention now turns to today's September non-farm payrolls report. Economists are looking for job creation in the region of 85,000 to 90,000, with unemployment expected to remain close to 4.1% and wage growth holding firm.

The dollar index has pushed to fresh highs for the year above 101.80. A resilient employment report could reinforce the view that the Fed can remain patient without materially weakening the US growth story, leaving scope for further dollar strength towards the 102.85 area.

GBP: Sterling pushes back above 1.17

Sterling has started October on the front foot, with GBP/EUR reclaiming 1.17 for the first time since early August.

The pound is benefiting from comparatively high UK yields, which continue to support sterling from a carry perspective. At the same time, near-term concerns surrounding the UK's fiscal position have eased somewhat as markets digest a more gradual approach to future spending commitments.

UK borrowing costs remain elevated, with 10-year gilt yields around levels not seen since 2007. While this remains a challenge for the domestic economy, it also keeps sterling relatively attractive against lower-yielding currencies.

For now, GBP remains well supported while UK yields stay elevated and wider market volatility remains contained.

EUR: French debt concerns pressure the single currency

The euro remains under pressure as investors focus on the deterioration in French government bonds and the potential implications for the wider euro area.

French borrowing costs have moved sharply higher, while spreads over German government debt have widened significantly. This has raised fresh questions over how aggressively the ECB can continue tightening policy if financial conditions deteriorate further.

EUR/USD broke to fresh lows for the year, with the technical picture now pointing towards the 1.1100 to 1.1120 region, while 1.10 remains a broader downside reference point.

The key risk for the euro is whether pressure in French bonds begins to spread more noticeably into other European sovereign markets. Any further reduction in expected ECB tightening would likely keep the single currency under pressure and limit the scale of any near-term recovery.

Looking ahead

• US non-farm payrolls: Markets are looking for roughly 85,000 to 90,000 new jobs, with unemployment expected near 4.1%.

• GBP/EUR: Sterling is back above 1.17, with French bond-market stress remaining an important driver.

• EUR/USD: The pair remains vulnerable following its latest technical break, with 1.11 now an important area to watch.

• Federal Reserve: Markets are increasingly leaning towards December rather than October for the next potential rate increase.

• European bonds: French yields and spreads remain a key barometer for euro sentiment heading into the end of the week.