Market overview

FX markets enter the session with a clearer risk premium across three fronts: Westminster instability, sticky US inflation and fragile Gulf diplomacy. Sterling is carrying the heaviest domestic burden as UK political risk returns to the fore, while the dollar remains supported by firmer Treasury yields after another uncomfortable CPI print. The euro, meanwhile, continues to trade as a proxy for risk sentiment and energy vulnerability.

For now, the market is rewarding yield, punishing uncertainty and leaving high-beta currencies exposed unless political and geopolitical headlines improve.

GBP: Westminster risk premium returns

Sterling finally showed clear UK-specific weakness yesterday as pressure on Prime Minister Keir Starmer intensified. He has signalled that he intends to remain in office and contest any leadership challenge, but markets are now focused on the timing and shape of any potential transition.

The immediate political calendar could offer a brief pause, with the State Opening of Parliament and the King’s Speech setting out Labour’s legislative agenda. However, any formal move from potential challengers such as Wes Streeting, Andy Burnham or Angela Rayner would likely renew pressure on the pound. Burnham would be watched particularly closely by gilt investors, given concerns around the fiscal implications of his policy stance.

The market reaction was uncomfortable. Sterling fell to the bottom of the G10 pack, while gilts sold off sharply, led by the long end. The 30-year gilt yield briefly rose to 5.81%, its highest level since 1998, before easing slightly. A weaker pound alongside weaker gilts is a familiar warning sign, pointing to a rising UK political and fiscal risk premium.

That said, sterling has not broken down. GBP/USD is drifting back towards 1.35, but even a move below that level would leave the broader rally from late March largely intact. Elevated UK yields are still offering some support, although we would expect EUR/GBP demand to emerge below 0.8650.

USD: Sticky inflation keeps the dollar bid

Markets absorbed yesterday’s CPI print without disorder, but the price action still leaned firmly towards a higher-for-longer Fed narrative. Two-year Treasury yields held near 4%, US equities stayed slightly softer and DXY finished higher on the day.

The inflation details were difficult to ignore. Headline CPI rose 0.6% month on month and 3.8% year on year in April, the fastest annual pace since May 2023. Core CPI increased 0.4% month on month and 2.8% year on year. Energy was a major driver, accounting for more than 40% of the monthly rise, while services ex-shelter and shelter inflation remain too firm for comfort.

This complicates the policy backdrop for Kevin Warsh, who is close to taking over the Fed chair. The Senate has confirmed his 14-year term as governor, with a separate chair vote expected as soon as today. His first full meeting in charge is set to be the June 16 to 17 FOMC, with another CPI report due on June 10.

Warsh may eventually make the case for lower rates if core inflation quality improves. Some of April’s firmness appears linked to technical distortions in rent sampling, while core goods pricing showed signs of cooling in areas such as vehicles, communication and medical care. Softer real income growth could also weigh on discretionary spending over time.

For now, however, the evidence is not yet strong enough to challenge dollar support. Hotter inflation, firm yields and limited near-term Fed easing expectations continue to make meaningful USD downside harder to sustain.

EUR: Geopolitics weighs on the single currency

The euro remains under pressure as risk sentiment softens and progress in the Gulf remains limited. Iran and the US have rejected each other’s recent peace proposals, while sporadic strikes have intensified and tensions around the Strait of Hormuz remain a key market concern.

We continue to see downside risks for EUR/USD. In the near term, weaker risk appetite is the main drag. Further out, the eurozone’s energy sensitivity leaves it vulnerable if tensions persist or the strait remains disrupted. That would challenge the credibility of any hawkish ECB stance, particularly relative to a Fed still supported by stronger US inflation and more resilient growth.

For now, EUR/USD looks likely to remain close to the 1.17 area until markets receive clearer signals on US-Iran diplomacy and the outlook for regional de-escalation.

President Trump’s upcoming Beijing summit is also in focus, with a delegation of leading technology executives expected to attend, including Nvidia co-founder Jensen Huang. The event could lend support to equities if it produces constructive signals on tariffs, technology and geopolitical risk. That may help cushion euro downside in the near term, even if the broader bias remains fragile.

Looking ahead

• UK politics remains the key driver for sterling, with any formal leadership challenge likely to pressure GBP and gilts.
• The King’s Speech may offer a brief pause in Westminster manoeuvring, but markets are focused on Starmer’s political survival.
• US CPI has raised the bar for near-term Fed easing and should keep the dollar supported unless the next inflation print cools materially.
• EUR/USD remains vulnerable to weaker risk sentiment and continued disruption around the Strait of Hormuz.
• The Beijing summit could provide a short-term equity boost, helping limit FX volatility if headlines are constructive.