UK Budget, ECB and Fed dominate a crucial week for FX

Market overview

Currency markets face a defining week as investors navigate shifting interest rate expectations, global growth concerns and a series of major economic events. Wednesday's UK Budget and Federal Reserve decision, followed by Thursday's European Central Bank meeting, will provide crucial direction for sterling, the dollar and the euro. With traditional safe-haven demand changing and monetary policy expectations increasingly sensitive to economic risks, confidence and credibility are becoming just as important as interest rate differentials in determining currency movements.

Across global markets, risk appetite remains fragile as higher energy prices, geopolitical uncertainty and questions surrounding AI-driven growth weigh on investor sentiment. Equity markets have come under pressure, while renewed demand for government bonds and defensive currencies such as the Japanese yen and Swiss franc points to growing caution. However, tentative diplomatic progress in the Middle East has offered some relief, potentially easing pressure on energy markets. With several major policy announcements approaching, investors are positioning for a week in which fiscal discipline, central bank guidance and broader market sentiment could drive significant currency movements.

GBP: Sterling faces a crucial test of confidence

Sterling enters the week on relatively firm footing, supported by resilient UK economic data and growing expectations of a Bank of England interest rate increase in November. Stronger inflation and employment figures have reinforced the pound's yield advantage, helping GBP/EUR reach a 12-month high of 1.1959 last week, while GBP/USD has approached 1.34.

However, Wednesday's Budget presents a significant test. Chancellor John Healey must convince investors that the government's borrowing plans remain sustainable, particularly following September's £24.5 billion borrowing figure, which exceeded official forecasts. Markets will scrutinise the accompanying Office for Budget Responsibility projections for evidence of fiscal discipline. A credible Budget could extend sterling's recent strength, while concerns over excessive borrowing risk pushing gilt yields higher and triggering a reversal in the pound.

USD: Safe-haven appeal weakens ahead of the Fed

The dollar has struggled to maintain its defensive appeal as investors increasingly favour the yen and Swiss franc during periods of market uncertainty. Concerns surrounding AI-related growth expectations have prompted a rally in US government bonds, pulling the 10-year Treasury yield below 5% and encouraging a modest reassessment of the Federal Reserve's interest rate outlook.

Wednesday's Fed decision is expected to leave rates unchanged, making the accompanying guidance particularly important. While markets have become slightly less convinced of further tightening, expectations of a potential December increase remain intact, limiting the scope for sustained dollar weakness. Meanwhile, signs of diplomatic progress in the Middle East could improve investor sentiment, although a corresponding decline in oil prices may remove some of the support previously enjoyed by the greenback.

EUR: French fiscal relief offers cautious support

The euro has recovered some ground following Moody's decision to maintain France's sovereign credit rating, providing welcome reassurance to European bond markets. The decision has eased immediate concerns over French borrowing costs, although political uncertainty and the challenge of securing approval for the country's 2027 Budget continue to cloud the outlook.

Thursday's European Central Bank meeting now takes centre stage, with policymakers widely expected to leave the deposit rate unchanged at 2.50%. President Christine Lagarde's assessment of inflation and financial stability will be closely examined for clues about December's policy direction. A firm commitment to containing inflation could help limit euro weakness, while any softer messaging may increase selling pressure. EUR/USD remains close to 1.12, with a more hawkish Federal Reserve potentially exposing the pair to a move towards 1.1113.

Looking ahead

• Wednesday, 28 October: UK Budget (12:30 UK time). Chancellor John Healey's fiscal plans and updated OBR forecasts will be critical for sterling and gilt market confidence.

• Wednesday, 28 October: Federal Reserve decision. Interest rates are expected to remain unchanged, with attention on the outlook for further tightening in December.

• Thursday, 29 October: ECB decision (13:15 UK time). President Lagarde's press conference at 13:45 will provide further insight into inflation risks and the prospect of additional rate increases.

• Throughout the week: Developments in the Middle East, energy prices and global equity markets will remain important influences on risk appetite and demand for defensive currencies.