Sterling under fiscal pressure
After ranking as the second-best performing G10 currency last week, sterling has slipped back at the start of this week. GBP/USD is struggling to hold the $1.35 level, while GBP/EUR has stalled around its 50-day moving average at €1.16, a threshold not decisively broken since mid-June.
Stronger GDP figures had briefly eased concerns about stagflation, but with growth expected to moderate in the second half of the year and inflationary pressures proving stubborn, the Bank of England’s policy outlook remains uncertain. This clouds the sustainability of the pound’s recent yield-driven gains.
Adding to the pressure, thirty-year inflation-linked gilt yields have surged to their highest since 1998, surpassing levels seen during the Truss-era turmoil. Higher borrowing costs are fuelling doubts about the UK’s fiscal sustainability, particularly with the government’s savings buffer diminishing ahead of the autumn budget. Chancellor Reeves risks breaching her own fiscal rule unless tax rises are considered — a politically delicate step that could undermine investor confidence.
All eyes are now on tomorrow’s July CPI release, expected to show headline inflation ticking up to 3.7 per cent. That outcome would reinforce expectations for the Bank of England to hold rates at 4 per cent into year-end. Normally, such a stance would be supportive for sterling, but lingering worries about weak growth and fiscal fragility may limit upside gains.
Euro steady ahead of Jackson Hole
The euro has spent the past ten sessions consolidating just above $1.16, with EUR/USD trading sideways in remarkably subdued conditions. Volatility has fallen to its lowest level since March, even with the Jackson Hole Symposium looming as a potential catalyst.
Positioning data suggest traders are cutting back bullish bets, reflecting a more cautious short-term tone. With conviction fading, EUR/USD is likely to remain range-bound into the week’s close.
Nonetheless, the broader structural case for the euro remains intact. Despite its summer setback, the single currency retains long-term appeal as an emerging reserve anchor. Europe’s policy focus has shifted towards infrastructure and defence investment, which could provide medium-term growth momentum. From a technical perspective, the charts still counsel caution, but the macro backdrop — monetary divergence, reduced trade-war risks, and ongoing eurozone inflows — continues to support a gradual upside bias.
The yield curve and the dollar’s path
The US Treasury market is undergoing a bear steepener, with both short- and long-term yields rising but longer maturities moving faster. The spread between 30-year and 2-year bonds has widened to +117 basis points, its highest in three years. This marks a sharp reversal from the deep inversion seen through 2022 and 2023, and suggests the market is shifting from recession fears towards expectations of sustained growth and persistent inflation.
The dynamic is being driven by multiple factors: sticky inflation, stronger nominal growth underpinned by fiscal spending, heightened term premia, the so-called ‘AI boom’, and heavier Treasury issuance. Historically, such episodes — as in 1994–95, 2013 and 2021 — have favoured cyclical equities such as financials and value stocks while weighing on long-duration bonds.
For the dollar, this shift is particularly significant. The greenback has already fallen around 9 per cent year-to-date, and the steepening curve points towards continued weakness. Higher long-term yields reduce the relative attractiveness of US assets, while stronger growth expectations encourage capital to flow towards riskier opportunities abroad.
The trajectory ahead hinges on whether this bear steepener ultimately morphs into a bull steepener — a scenario where short-end yields fall faster, usually triggered by Federal Reserve rate cuts in response to weakening economic conditions. If labour markets soften meaningfully and core inflation retreats, the Fed could be forced into a more aggressive cutting cycle, accelerating dollar downside.
For now, however, a September cut looks unlikely. Despite dovish remarks from some policymakers, two dissenting votes at the July FOMC meeting, and softer payrolls, Powell is unlikely to shift course substantially given firmer unemployment and inflation data. Mixed signals from July’s CPI and PPI — cooling in some tariff-affected goods but persistent service-sector pressures — only reinforce the Fed’s caution.
In short, the yield curve’s current three-year high reflects the market’s scepticism over a smooth disinflationary path. Powell’s emphasis on prioritising inflation over growth suggests a shallow, later-starting easing cycle, consistent with the ongoing bear steepener. The dollar’s outlook will remain closely tied to whether this steepening trend persists or the economy weakens enough to force a decisive shift.
