Market overview

FX markets remain caught between competing drivers, with rate expectations, risk sentiment and geopolitical headlines all shaping price action. The recent improvement in risk appetite has been uneven, as equity volatility, oil sensitivity and uncertainty around US-Iran tensions continue to keep investors cautious.

The rates story remains central. Stronger US data has pushed markets to reassess the timing of potential Fed easing, while the ECB faces the challenge of tightening into a softer eurozone growth backdrop. That divergence is keeping yield differentials in focus and limiting conviction across major currency pairs.

Sterling has benefited from a steadier risk tone and supportive carry, although domestic macro concerns continue to cap enthusiasm. The euro remains more exposed to the balance between ECB policy support and weakening regional activity, while the dollar is still drawing support whenever markets lean back towards defensive positioning.

With US inflation due today and the ECB decision approaching, FX volatility is likely to stay elevated. For now, markets are trading less on a single dominant theme and more on how inflation, central bank guidance and geopolitical risk interact from one session to the next.

USD: inflation data holds the key

The dollar has regained some ground as investors reassess the balance between resilient US activity, sticky inflation risk and safe-haven demand. The move has been helped by a softer tone in equities and renewed caution around US-Iran tensions, although much of the earlier equity weakness has since stabilised.

The latest US labour report reinforced the view that the Fed has room to keep policy restrictive for longer. Hiring remains firm, while softer wage growth and signs of cooling consumer demand make the case for further tightening less clear. For markets, the message is that the Fed is not under pressure to cut, but also has limited incentive to hike unless inflation forces its hand.

Today’s CPI report is therefore the main catalyst. Expectations are centred on a 0.5% month-on-month increase, taking the annual rate to 2.9%. A hotter print would likely push US yields higher, strengthen the dollar and renew pressure on risk assets. A softer reading would give investors room to unwind part of the recent hawkish repricing.

Oil remains a secondary but important risk. Any sustained move higher in crude would complicate the inflation outlook at exactly the point markets are reassessing the Fed path. For now, the dollar remains well supported, but the next leg will depend heavily on whether the inflation data validates the market’s recent shift.

GBP: supported, but still range-bound

Sterling was firmer yesterday as a steadier risk backdrop helped lift pro-cyclical currencies. Investors have so far looked through the latest exchange of strikes between the US and Iran, focusing instead on official messaging that frames the moves as limited and defensive. That has prevented a deeper deterioration in sentiment.

GBP/USD has recovered from the 1.33 area and is trading around 1.3390, back in the middle of the range seen since mid-May. GBP/EUR is steady near 1.1586, helped by a softer euro before Thursday’s ECB decision.

Positioning remains an important support. A crowded short base, attractive carry versus much of G10 and a largely priced-in domestic political risk premium are helping to contain sterling downside, even as the UK macro outlook remains fragile.

The 200-day moving average near 1.3420 is the level to watch for GBP/USD. A stronger-than-expected US CPI print would likely limit any sustained break above 1.34, particularly if it reinforces the Fed higher-for-longer narrative. Geopolitical headlines may still generate intraday swings, but lasting upside in sterling likely requires a softer dollar backdrop rather than risk sentiment alone.

EUR: ECB support looks less straightforward

For the euro, Thursday’s ECB meeting is less about whether policymakers raise rates and more about whether further tightening can still support the single currency. Markets have already priced in much of the ECB’s hawkish path, with close to three hikes discounted by year-end. That leaves limited room for further supportive repricing unless the Governing Council delivers a materially tougher signal.

The eurozone backdrop is less encouraging. Growth indicators remain soft, energy prices continue to weigh and Middle East uncertainty is starting to feed more directly into confidence and activity data. In that environment, additional ECB tightening risks being viewed as a drag on growth rather than a clear euro positive.

EUR/USD has moved towards 1.1550, but the rally looks vulnerable. Stronger US data and persistent inflation concerns have restored some of the dollar’s yield advantage, while the ECB faces the risk of delivering a dovish hike. If rates rise but guidance stresses caution and optionality, the euro could come under renewed pressure.

Updated ECB staff forecasts will be important. Higher inflation projections alongside weaker growth assumptions would reinforce stagflation concerns and make EUR rallies harder to sustain. A short-term bounce is possible if the ECB sounds firm or if geopolitical tensions ease, but a durable move higher needs either better eurozone data or a softer Fed outlook.

Looking ahead

• US CPI is today’s main event, with an upside surprise likely to support the dollar and lift US yields.
• Oil remains a key inflation risk, particularly if Middle East tensions push crude materially higher.
• GBP/USD needs a softer dollar backdrop to reclaim the 200-day moving average near 1.3420.
• GBP/EUR may test 1.16, but a clean break looks unlikely before the ECB decision.
• The ECB meeting could weigh on EUR if policymakers hike while signalling caution on further tightening.