Sterling in the Firing Line as BoE Decision Looms
The Bank of England is widely expected to reduce interest rates by a quarter of a percentage point to 4 per cent today. However, recent data has painted a mixed picture of the economy, and we anticipate a divided vote among the Monetary Policy Committee. It is likely that two members will argue for no change, while another two may push for a more forceful half-point reduction. The lack of consensus reflects the Bank’s ongoing struggle to balance persistent inflation with signs of weakening growth.
Given that markets have already factored in today’s cut, attention will turn to the Bank’s tone and forward guidance. A key question is whether the BoE will signal continued quarterly reductions or suggest a shift in its approach. Much hinges on how the Bank assesses the state of the labour market. Thus far, the data suggests a gradual softening rather than an abrupt contraction. Meanwhile, core inflation, particularly in services, remains uncomfortably high, complicating the monetary policy picture.
We expect the Bank’s updated economic forecasts to remain largely in line with those released in May. Inflation is likely to be projected as stable, GDP may be revised marginally higher due to fading tariff-related headwinds, and the labour market outlook could be slightly more subdued. The Bank may also address the impact of quantitative tightening on bond yields. Should active gilt sales be pushing yields higher than anticipated, a moderation in the pace of those sales may be considered.
Ultimately, the question of whether the BoE leans hawkish or dovish is less important than the fact that sterling faces risks in either direction. Market pricing currently reflects just 60 basis points of easing by February. If the Bank sticks to its usual pace of cuts, this appears too modest, suggesting that more rate reductions may need to be priced in – a development likely to weigh on the pound through lower yields. On the other hand, if the Bank adopts a firmer tone due to inflation risks, higher nominal rates may not translate into higher real returns if economic growth continues to falter and inflation expectations remain elevated.
The pound therefore finds itself in a precarious position, especially against the euro. Seasonal patterns offer little comfort either. August has historically been a difficult month for GBP/USD, and the pair’s recent inability to break above key resistance from the 100-day moving average may be an early warning of further weakness.
Changing of the Guard? Dollar Faces Political and Policy Headwinds
As the full impact of new US trade tariffs continues to unfold, pressure is mounting on the Federal Reserve to adopt a more accommodative stance. President Trump’s announcement that a new nominee for the Federal Reserve Board will be named by the end of the week has added to market uncertainty. He revealed that four candidates are under consideration for the role of Fed Chair, including two individuals named Kevin. Of these, former FOMC member Kevin Warsh appears to be the frontrunner to replace Jerome Powell.
This move raises the prospect of a shadow central bank taking shape before any official change in leadership, a development that could dampen confidence in the Fed’s independence and add volatility to the dollar.
Further contributing to the dovish momentum is recent commentary from Minneapolis Fed President Neel Kashkari. In a televised interview, he remarked that the economy is showing clear signs of slowing, and that it may soon become necessary to lower the federal funds rate. He acknowledged the uncertainty surrounding the inflationary impact of tariffs, and suggested it might be better to begin adjusting policy pre-emptively rather than waiting for full clarity. His comments imply that a gradual easing approach, even if it includes pauses or reversals, could be more prudent than holding rates steady for too long.
Meanwhile, the 10-year breakeven rate, which serves as a key measure of long-term inflation expectations, has been steadily rising since April. Real yields have fallen and the yield curve has steepened – developments that have put pressure on the dollar, especially as fears about a broader economic slowdown grow.
As investors begin to focus less on global shocks and more on bilateral agreements and national data, macro indicators such as inflation and growth are receiving greater scrutiny. Emerging economies, particularly China, could provide early signals about the direction of global demand. The recent rally in US financial assets, despite softer commodity prices, reflects a growing scepticism about the strength of global growth outside the United States. However, the dominant narrative of a soft landing for the US economy remains intact – for now. Should that confidence waver, the dollar may be vulnerable to a sharp reassessment.
Euro Regains Ground as Policy Divergence Reasserts Itself
The euro’s recent losses against the dollar have been reversed more quickly than expected. EUR/USD surged following last week’s weak US employment data and has continued to climb, rising a further 0.7 per cent this week. The pair is now comfortably trading above its 21-day moving average.
The relationship between EUR/USD and short-term yield spreads has regained strength, returning to the highs seen earlier in 2025. This correlation had weakened when the euro was briefly treated as a safe haven during heightened fears of a US recession. With monetary policy divergence once again in focus, the euro appears well positioned to benefit if the Federal Reserve adopts the more dovish stance currently being priced in by markets.
Expectations for the Fed have shifted significantly. Traders are now anticipating up to 75 basis points of rate cuts by the end of the year, driven by soft economic data and renewed concerns about growth. Demand for Treasuries has increased, and positioning in rate-sensitive assets reflects growing conviction in a more accommodative Fed.
By contrast, the European Central Bank has been more circumspect. Market pricing suggests less than a 50 per cent chance of further rate cuts, and several policymakers have expressed doubts about the need for additional easing. Outgoing ECB hawk Robert Holzmann, among others, has argued that inflation is nearing target and external risks have diminished following the recent US–EU trade agreement.
President Trump’s latest tariff threats have added another layer of uncertainty, fuelling fears that the US economy could suffer more than its trading partners. This has supported the view that the euro may offer a relatively more stable option for investors, particularly if rate differentials continue to shift in its favour.
