UK economy beats expectations, lifting pound outlook
Recent figures show the UK economy made a much stronger start to 2024 than forecast, with GDP expanding by 0.7 percent in the first quarter. This marks a clear improvement from the modest 0.1 percent growth seen at the end of last year. March contributed a further 0.2 percent rise, and exports climbed to their highest level in two years. However, this data does not yet reflect the potential effects of the recent Liberation Day tariffs.
The labour market presents a more complex picture. Wage growth remains elevated at 5.6 percent on an annual basis, although it appears to be flattening. This is raising concerns about whether such pay increases are sustainable for employers. The employment rate stayed at 75.0 percent, while unemployment inched up to 4.5 percent. This points to ongoing difficulties in recruitment. Job vacancies continued to decline, falling to 761,000 and maintaining a steady downward trend.
The combination of robust economic growth and persistent wage pressure could lead the Bank of England to hold off on cutting interest rates. Market expectations have now shifted, with August seen as the most likely month for any change in policy.
Turning to the pound, market sentiment has turned increasingly optimistic. Bullish positions on sterling have reached their highest level in five years, with one-month GBP/USD risk reversals showing rising demand for the pound. Options pricing suggests traders are growing more confident. Speculation that Donald Trump may support a weaker US dollar has pushed one-year GBP/USD risk reversals to levels last seen in 2009.
Sterling could find additional support from next week’s UK-EU summit. New economic measures are expected to be announced, and if these are seen as supportive of future growth, they may influence expectations around monetary policy and add further momentum to the pound.
Pound outlook shaped by EU-UK negotiations and investor confidence
The near-term performance of the Pound against the Euro is likely to be influenced by the outcome of upcoming EU-UK talks. Discussions are expected to cover key areas such as security, youth mobility, and trade. Any meaningful agreement could support further gains in Sterling, which has already benefited from expectations of progress. However, recent media reports suggest there is a risk of disappointment early next week.
Several contentious issues remain unresolved. These include EU access to UK fishing waters and the potential reinstatement of free movement for under-30s. Both are politically sensitive topics, especially given the current scrutiny of immigration and the pressure on Keir Starmer to deliver credible policy solutions. If the negotiations result in a limited agreement focusing only on defence cooperation, financial markets may view the outcome as underwhelming. This could see GBP/EUR slip below 1.19 and move towards the lower 1.18 range.
In the short run, the outcome of these talks is likely to dominate market focus. However, the broader direction of the currency pair will depend more heavily on changes in global investor sentiment. So far, improved confidence has helped keep the Pound relatively resilient.
Sterling continues to reflect trends in equity markets and was hit hard in April when volatility spiked following Donald Trump’s early-month tariff announcements. Since mid-April, calmer conditions have allowed GBP/EUR to recover gradually.
Some analysts believe that much of the positive news may already be reflected in prices, especially following the temporary easing of trade tensions between the United States and China. Even so, uncertainty surrounding future trade policies continues to hold back spending and investment decisions. This has also cast doubt on the likelihood of early rate cuts by the Federal Reserve.
Should global sentiment deteriorate, the Euro may start to attract more support. Fiscal policy developments in the United States could also influence this dynamic. Reports suggest Republican lawmakers are considering a significant debt ceiling increase, potentially adding $4 trillion in borrowing through a new budget reconciliation package. This could push the federal deficit close to 6.5 percent of GDP in the coming years. If international investors are reluctant to absorb this additional debt, market instability may follow, weakening risk sentiment and putting pressure on Sterling.
For now, this remains a secondary risk. Provided equity markets continue to perform and U.S. data does not signal an imminent downturn, the most likely path for GBP/EUR remains higher, with a sustained move above 1.19 still expected.
Weak US data puts pressure on the dollar as economic momentum fades
The dollar came under renewed pressure towards the end of the week following a disappointing batch of US economic figures. April’s retail sales report pointed to a slowdown in consumer activity, suggesting that the surge in March spending, likely driven by early purchases ahead of anticipated tariffs, has now run its course. At the same time, figures on producer prices indicated subdued inflationary pressures, hinting that firms may be absorbing rising costs, although this may not be sustainable over time.
Headline retail sales in April edged up by just 0.1 percent, with the majority of spending categories recording declines. This highlights a broader weakening in household demand. In addition, producer prices fell by the largest margin in five years, offering further evidence of softening price pressures. The data points to only a slight 0.1 percent monthly rise in the Federal Reserve’s preferred inflation measure, the core PCE deflator. However, previous readings on producer prices have been revised higher, creating some uncertainty around the trend.
Elsewhere, regional business surveys painted a mixed picture. The New York and Philadelphia Federal Reserve reports indicated that business conditions had worsened overall, although both noted an increase in new orders. Despite the expectation of higher raw material costs in the months ahead, this rise in demand suggests that the national ISM manufacturing PMI could see a modest improvement in May.
