GBP/EUR presses 2026 highs as euro risks remain

Market overview

FX markets are starting the session with a mixed but relatively orderly tone. The dollar is softer after an improved session for bonds helped US equities reach fresh highs, while sterling remains firm and the euro is attempting to stabilise as French sovereign stress eases. Energy remains an important cross-market driver, with Brent rebounding after briefly dipping below $100 a barrel. Higher oil prices continue to complicate the inflation outlook and are limiting the scope for a sustained rally in global bonds.

Attention now shifts back towards monetary policy and sovereign risk. The September FOMC minutes will be closely watched for guidance on how much further the Fed believes rates may need to rise, while developments in France remain central to the euro outlook. French bond spreads have narrowed, but investors are still questioning whether the improvement can be sustained without greater clarity on the fiscal path.

USD: Fed minutes face a high bar

The dollar weakened yesterday as lower yields reduced demand for defensive positioning, but the broader backdrop remains supportive. Persistent strength in energy prices continues to keep inflation risks alive, which in turn limits the scope for a meaningful fall in US yields.

Today's September FOMC minutes are unlikely to deliver a major dovish surprise. The latest dot plot showed four policymakers expecting two further hikes this year, compared with only two expecting no additional tightening.

That said, softer data since the September meeting and firm market expectations for a December increase mean the bar for a fresh dollar rally is relatively high. DXY may find support around the 102.0 area, although the balance of risks still appears tilted higher.

GBP: Sterling presses against 2026 highs

Sterling continues to trade close to its strongest levels of the year against the euro, with GBP/EUR testing the 1.18 area. A sustained break above this level would strengthen the technical case for a move back towards the 1.1820 region and potentially further into the upper 1.18s.

The move is being driven largely by weakness in the euro rather than a significant change in the UK outlook. Concerns over French borrowing costs and the possibility of a more cautious ECB stance are keeping relative rate expectations supportive for sterling.

For now, GBP/EUR remains well positioned, although a clean close above 1.18 would provide a stronger signal that the recent move has further room to run.

EUR: French relief helps, but risks remain

French sovereign bonds extended their recovery yesterday, with the 10-year spread over German Bunds narrowing to around 125 basis points. Improved global bond sentiment helped, while Marine Le Pen's pledge to reduce the budget deficit to 3.7% of GDP next year also provided some support.

Markets remain cautious, however. The proposed fiscal adjustment relies heavily on significant spending cuts, including potentially difficult reforms to pensions, and investors are yet to see a fully costed plan. The French-Italian 10-year spread also remains elevated, suggesting a meaningful political and fiscal premium is still embedded.

The euro initially benefited from tighter French spreads, but the recovery has faded as oil prices moved higher. EUR/USD remains vulnerable to a move back towards the 1.1150 to 1.1180 area, while EUR/GBP continues to hold above the 0.8450 region. EUR/CHF has also recovered part of October's losses, although a sustained break above 0.940 would probably require a broader improvement in confidence towards the French fiscal outlook.

Looking ahead

• FOMC minutes: Markets will focus on the Fed's reaction function and the conditions that could justify further tightening.

• Oil prices: Renewed strength in Brent remains important for inflation expectations, bond yields and the dollar.

• French sovereign spreads: Further tightening could offer the euro some support, but investors remain cautious on fiscal credibility.

• GBP/EUR: A close above 1.18 would strengthen the case for a move towards the year's highs.

• EUR/USD: The 1.1150 to 1.1180 area remains an important near-term downside zone.