The Pound to Euro (GBP/EUR) exchange rate remains under pressure after the Bank of England’s decision to leave interest rates unchanged and signal further cuts into 2025. The Pound fell sharply, testing support at 1.2030, where buying interest has emerged. While holiday-thinned markets could exaggerate moves, analysts remain optimistic about a medium-term recovery into the early 1.20s, supported by Eurozone challenges in France and Germany and expectations of deeper European Central Bank rate cuts. However, a sustained recovery would require a break above key resistance, such as the nine-day exponential moving average.

The Pound to Dollar (GBP/USD) exchange rate has fallen to a seven-month low of 1.2472 amid U.S. political turmoil and safe-haven Dollar strength. Republican opposition to a bipartisan spending bill and President-elect Trump’s tariff threats have heightened market anxieties. Technical indicators suggest further downside, with the April 2024 low of 1.23 in focus. The Pound remains vulnerable in the near term, with its trajectory likely influenced by developments in U.S. fiscal and trade policies heading into 2025.

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Pound Under Pressure as Bank of England Signals Potential Rate Cuts

The pound faced downward pressure after the Bank of England (BoE) kept its Bank Rate steady at 4.75%, as expected. The market-moving development came from three policymakers voting for a rate cut, compared to the previous 8-1 split favouring a hold. This shift sent a dovish signal, lowering short-dated gilt yields and weakening sterling.

The greater dissent surprised markets, though it was supported by the committee’s dismissal of stronger pay data as “more volatile than other wage indicators.” Additionally, softer data on economic activity and employment appeared to influence the decision. Analysts now anticipate the BoE will likely cut its key interest rate by 25 basis points in February, continuing a “cut-hold” approach. Market expectations for a February cut have risen from 50% to over 70%, though just 57 basis points of rate cuts are priced in for 2025—well below the 100 basis points projected by BoE Governor Andrew Bailey. Should market pricing adjust to align with BoE projections, the pound could face further depreciation in 2025.

The GBP/USD pair has dropped to a six-month low, slipping below its key support and the $1.25 Interbank (IB) support level. With the relative strength index yet to signal oversold conditions, further declines are possible. Meanwhile, GBP/EUR has fared better, buoyed by favourable rate differentials and the euro’s internal bearish factors.

UK Retail Sales Highlight Consumer Caution Amid Economic Slowdown

New data from the ONS reveals continued caution among UK consumers, adding pressure on retail businesses and offering further signs that the economy has entered a downturn.

Retail sales rebounded from a -0.7% decline month-on-month in October to a modest 0.2% growth in November, falling short of market expectations of 0.5%. Notably, November is typically a crucial month for UK retailers due to the Black Friday shopping event, making the weaker-than-expected performance particularly concerning.

Retail sales, a key indicator of demand and sentiment in the UK's service-driven economy, play a vital role in shaping overall economic performance. The weaker-than-expected figures provide further evidence of declining momentum as the economy heads toward year-end, adding to a series of recent disappointments.

Euro Faces Challenges Amid Fed-ECB Divergence and Weak Data

The euro appears to be consolidating support near the $1.0350 IB level, as it grapples with widening policy divergence between the Federal Reserve and the European Central Bank (ECB), coupled with weak domestic economic data. A close below $1.0410 at IB today would mark the euro's lowest weekly close against the dollar this year. The final opportunity for euro bulls to shift momentum before the weekend lies in the release of the US PCE inflation report. Consensus forecasts suggest a decrease in core price growth from 0.3% in October to 0.2% in November, while personal spending is expected to rise from 0.4% to 0.5%.

Upside surprises in consumption data remain a possibility, which could hinder the euro’s ability to recover and end the week positively. Such an outcome would mean EUR/USD has declined in six of the past seven weeks. With no significant economic data expected until year-end, the currency pair is on track to close 2024 with a loss. Additionally, if the euro fails to climb back above $1.05 at IB within the next 11 days, it will record its lowest annual close since 2002.

Market Sentiment Deteriorates Amid US Spending Bill Failure

Financial markets turned sour to close the week after a bill to extend US government funding until March 14 failed to secure the required two-thirds majority in Congress. With a deal needed today to avoid a government shutdown, equities futures have fallen into negative territory, while the US dollar—bolstered by its safe-haven and high-yielding appeal—has gained modest strength against other currencies.

The House of Representatives rejected the Trump-backed spending package, prompting concerns over future legislative chaos should Trump return to the White House. This risk-off sentiment has kept the US dollar index hovering around 108.5, its highest level since November 2022. Investors are also closely watching the release of the PCE price index, the Federal Reserve's preferred inflation gauge, which is expected to show inflation still above the Fed’s 2% target.

The Fed’s recent quarter-point rate cut, delivered alongside hawkish guidance, highlighted persistent inflationary pressures. The central bank now anticipates only two rate cuts in 2025, a sharp reduction from the four cuts projected in September, signalling a more cautious approach to monetary easing.

Federal Reserve Concludes Year with Third Rate Cut Amid Rising Inflation Concerns

The Federal Reserve has reduced interest rates by 25 basis points, concluding the year with a total of three rate cuts amounting to a 1% easing. This adjustment brings the federal funds rate to 4.25%. The Summary of Economic Projections indicates a median forecast of two rate cuts next year, alongside an upward revision of the year-end inflation projection for 2025 to 2.5%.

Policy makers appear to have underestimated inflation risks in recent years. Since the early price increases in 2021, the Federal Open Market Committee (FOMC) has primarily focused on its preferred measure, core PCE inflation. By 2022, their stance became more cautious than inflation data warranted. This caution eased in September, as only three FOMC members then perceived upside risks to core PCE inflation.

However, inflation concerns have resurfaced. The number of FOMC members recognizing upside risks to core PCE rose sharply from three to 15, marking the largest meeting-by-meeting increase since 2017. The median inflation forecast for 2024 also rose from 2.1% to 2.5%. This upward revision, combined with dissent from Cleveland Fed President Beth Hammack and heightened inflation risk perception, sets the stage for a potential pause in rate adjustments at January’s meeting. Investors interpreted this meeting as a hawkish signal despite the rate cut.

Euro Slips Below $1.04 as Fed’s Hawkish Cut Rattles Markets

The euro dropped below the critical $1.04 support interbank (IB) level for only the second time this year after the Federal Reserve delivered a hawkish rate cut yesterday evening. The move unsettled global equity markets, with investors reacting to the possibility of a more cautious stance from the US central bank, resulting in widespread losses across major indices.

The VIX, a key measure of implied stock market volatility, surged, doubling its level after the Fed meeting and setting up for its largest weekly increase since the pandemic. Market attention now shifts to central bank decisions in Norway, Sweden, the UK, Mexico, Taiwan, and the Philippines, with investors watching closely for any ripple effects from the Fed's policy shift.

As anticipated, the euro’s movements remain closely tied to US developments. Following the Fed’s decision, markets are now bracing for tomorrow’s US inflation data. Meanwhile, today’s GfK consumer survey from Germany failed to lift spirits, as consumer confidence remained in negative territory for December—a trend persisting since late 2021.

Bank of England Expected to Hold Rates Steady Amid Inflation Concerns

The Bank of England (BoE) is anticipated to leave the Bank Rate unchanged at 4.75% today, aligning with consensus expectations and market forecasts. Investors will focus on the vote split and any forward guidance, particularly whether the BoE hints at a potential rate cut in February or adopts a more cautious stance, akin to the Federal Reserve, in response to unexpected wage growth.

The Monetary Policy Committee has signalled a measured approach to policy easing, interpreted as quarterly rate cuts, which are likely to extend into 2025 given that economic data aligns with their projections. However, this week’s strong UK wage growth and persistent inflation have tempered market expectations, reducing anticipated rate cuts next year to fewer than two 25-basis-point reductions. UK gilt yields are approaching one-month highs, with the UK-German 10-year spread reaching levels last seen in the 1990s, pushing GBP/EUR past the €1.21 IB mark.

Meanwhile, GBP/USD is edging closer to the $1.26 IB level after the Fed’s hawkish decision last night. The pair experienced its steepest decline in over a month and remains in a downtrend since peaking at $1.34 at IB in late September. A hawkish tone from the BoE today could offer some relief, though short-term prospects for GBP/USD remain uncertain.

Fed Rate Decision: Hawkish Signals or Dovish Surprises?

The US Federal Reserve is widely expected to deliver another 25-basis point rate cut later today, with markets assigning a 95% probability to this outcome. Consequently, market volatility is more likely to stem from the Fed’s updated dot plots and economic projections. Should the tone lean unexpectedly dovish, the USD could weaken, especially given its 6% rally this quarter.

Market sentiment is largely tilted toward a hawkish stance, supported by ongoing US economic strength and the potential for fiscal stimulus under President-elect Donald Trump. Recent data highlights this resilience: US composite PMI climbed to its highest level since March 2022, driven by strong performance in the services sector, while retail sales rose 0.7% month-on-month in November, following an upwardly revised 0.5% gain in October. These indicators point to robust consumer spending and business activity, prompting markets to scale back expectations for further rate cuts next year. The projected interest rate path now exceeds the Fed’s current dot plot, setting a high bar for additional easing.

Additionally, policymakers may revise their inflation outlook as they prepare to pause rate cuts in January. In September, only three FOMC members anticipated upside risks to core PCE inflation, but this assessment is likely to shift higher. However, if upgrades to the 2025/26 economic forecasts fall short of market expectations, the USD may face downward pressure.

Sterling Slips as UK Inflation Meets Expectations

The pound retreated from yesterday’s highs after UK headline inflation for November came in line with forecasts. While core inflation reached a three-month high, a closely watched measure of services inflation, important to Bank of England (BoE) policymakers, was slightly lower than anticipated. As a result, GBP/EUR has dropped below €1.20 at Interbank (IB), and GBP/USD has slid back under $1.27 IB.

This inflation release was the final major data point ahead of the BoE’s last policy meeting of 2024, scheduled for Thursday. Strong wage growth data from yesterday led traders to reduce expectations for BoE rate cuts next year, with markets now pricing in two cuts in 2025, down from three earlier this week. However, despite resilient wage growth and persistent inflation, signs of weakness in the labour market and slowing economic activity are fuelling concerns over stagflation. This growing uncertainty suggests sterling may find less support from elevated UK rates moving forward.

Euro Slides Below $1.05 Amid Strong US Data and German Political Turmoil

The euro dipped below the $1.05 IB level as stronger-than-expected US macroeconomic data and escalating German political uncertainty weighed on the currency. In November, political instability in Europe’s largest economies reached new highs, with governments either collapsing or operating in minority positions as fiscal deadlines loom.

France is projected to grow modestly by 0.2% in the first half of 2025, according to the Insee institute. However, Germany faces a potential third consecutive year of contraction in 2025, further clouding the region's outlook.

Key catalysts for the euro’s near-term direction include developments in German and French politics, as well as the Federal Reserve’s policy decision later today. A sustained break below $1.05 IB by the end of the week could signal deeper trouble for the currency.