Pound Faces Worst Week Since July 2023 Amid Economic Pressures

Last week the British pound experienced its steepest weekly decline since July 2023, dropping by 1.8% from $1.34 to $1.31 against the US dollar. Sterling was weighed down by a combination of risk aversion, strong US economic data, and dovish remarks from Bank of England (BoE) Governor Andrew Bailey. As a result, the market has adjusted to anticipate consecutive interest rate cuts in the UK, reducing the rate advantage that had supported the pound earlier in the year.

Upcoming UK GDP data for August, set to be released on Friday, will reveal whether the economy returned to growth after stagnating in July. Meanwhile, downward revisions to final Q2 GDP data and September PMIs have opened the possibility for more aggressive monetary easing than initially expected. This shift, coupled with weakening growth and yield differentials, could keep demand for the pound subdued, potentially testing the $1.30 level for GBP/USD soon.

Despite the recent fall, the pound remains the best-performing G10 currency year-to-date. GBP/USD continues to hold within the top quarter of its 1-, 2-, and 3-year ranges, sitting three cents above its five-year average of $1.28.

U.S. Jobs Report Exceeds Expectations, Easing Concerns Over Labour Market Weakness

The September U.S. jobs report showed unexpectedly strong growth, with the labour market adding 254,000 net new jobs, far surpassing the forecasted 150,000. Additionally, July and August figures were revised upward, breaking the trend of downward adjustments seen in previous months. The unemployment rate also dipped to 4.1%. Combined with earlier data showing steady demand for workers, the report eases fears of a weakening U.S. labour market.

As a result, markets are now pricing in around 50 basis points of easing from the Federal Reserve by year-end, down from the 75 basis points anticipated two weeks ago. The next key test for Federal Reserve policy expectations is this week's U.S. CPI inflation report. However, it is unlikely to reignite expectations of large cuts, keeping the U.S. dollar stable around current levels.

The U.S. economy's resilience, along with diminishing bets on aggressive Fed easing, suggests the dollar's strength could persist. However, improved hopes for a soft landing, combined with China's recent stimulus measures and rising energy prices, may also lift global risk sentiment. In this environment, G10 high-beta currencies, especially those tied to higher commodity prices like the Australian dollar (AUD), Canadian dollar (CAD), and Norwegian krone (NOK), could perform well against the U.S. dollar.

The upcoming U.S. CPI inflation report this week will be the next key indicator for Fed pricing and, consequently, the U.S. dollar.

EUR/USD Falls Below $1.10 as Diverging Central Bank Policies Weigh on Euro

Last week's strong U.S. economic data sharply contrasted with weak Eurozone indicators, such as sluggish manufacturing PMIs and softening inflation. This divergence led to a re-pricing of both central banks' monetary policy outlooks, pushing EUR/USD below $1.10 for the first time in seven weeks. The U.S. Federal Reserve's policy trajectory remains the primary driver of the euro's decline.

Weaker economic activity and faster disinflation in the Eurozone have impacted European Central Bank (ECB) communications and market expectations, with a 95% probability now priced in for a 25-basis-point rate cut in October. As expectations for ECB rate cuts rise, while bets on U.S. Federal Reserve cuts diminish, the narrowing gap in easing expectations has dragged the euro lower. Despite stimulus efforts from China, EUR/USD has struggled to break above $1.12, indicating that any upward movement will depend on U.S. data, monetary policy developments, and factors like the U.S. election and trade policy.

This week, market attention will focus on Eurozone retail sales, ECB meeting minutes (Thursday), and comments from several ECB Governing Council members. With persistent economic weakness and the ongoing pace of disinflation in the Eurozone, further dovish signals from the ECB are likely to keep EUR/USD under $1.10 in the near term.