The United Kingdom's economy is edging closer to recession following the government's controversial budget, which has been criticised for being unfriendly to businesses. Sterling initially gained against the Euro as data revealed a sharp slowdown in the Eurozone economy during November. However, this optimism was short-lived as the UK’s own economic challenges were brought into focus. A Purchasing Managers’ Index (PMI) survey highlighted worsening business sentiment, largely attributed to the government's October fiscal policies. According to S&P Global, the UK composite PMI dropped to 49.9 in November from 51.8, reflecting contractionary pressures that underscore mounting economic challenges.

The UK's manufacturing sector has officially entered contraction, with the PMI falling to 48.6, down from 49.9 in the previous month, in line with global manufacturing headwinds. Alarmingly, the services sector, which forms the backbone of the UK economy, is now teetering on the brink, with a PMI reading of 50, a critical threshold, down from 52. The deterioration in sentiment and output across key sectors highlights a significant slowdown in economic activity. Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, noted the concerning outlook, stating that falling output and consecutive monthly job cuts point to a deepening malaise in the post-Budget economy.

The report also underlined the growing inflationary pressures facing businesses, with November witnessing a sharp rise in input costs, particularly in the service sector. This presents a difficult scenario for the Bank of England. While a weakening labour market might typically prompt rate cuts, rising inflation ties its hands. Currency markets reflected these challenges, with GBP/EUR briefly surging to 1.2094 before falling back to 1.2034, while GBP/USD continued its decline, hitting 1.2523 amidst robust U.S. economic performance. Investors have adjusted their expectations for UK interest rate cuts, now anticipating three reductions next year, with a February cut fully priced in. In contrast to the UK’s struggles, the U.S. economy continues to expand, leaving the Pound under sustained pressure against the Dollar. Meanwhile, lingering uncertainties in the Eurozone could provide limited support for the Pound against the Euro.

UK Retail Sales Decline in October Amid Budget Uncertainty

British retailers experienced a drop in sales last month, as uncertainty ahead of the autumn Budget weighed on consumer spending, according to official figures.  Clothing stores were hit particularly hard, with industry data suggesting that mild October weather deterred shoppers from purchasing warm winter clothing.

The Office for National Statistics (ONS) reported a 0.7% decrease in retail sales volumes — a measure of the quantity of goods sold — following a revised 0.1% growth in September (previously estimated at 0.3%). The October decline exceeded economists' forecasts of a 0.3% drop.

ONS senior statistician Hannah Finselbach commented:  “Retail sales fell back in October following three months of growth. The fall was driven by a notably poor month for clothing stores, but retailers across the board reported consumers held back on spending ahead of the Budget.  “However, when we look at the wider trend, retail sales are increasing across the three-month and annual periods, although they remain below pre-pandemic levels.”  Non-food stores reported a 1.4% drop in sales volumes in October, reversing the 2.3% growth recorded in September.

Euro Downtrend Deepens Amid Macro and Political Headwinds

The euro remains firmly in a downtrend, with EUR/USD falling in seven of the past eight weeks and breaking below the critical $1.05 support level on Thursday. While the pair nears oversold territory based on its 14-day relative strength index (RSI), other technical indicators suggest further losses are likely.

The 21-day moving average has consistently capped any rebounds since early October, while the formation of a "death cross" — where short-dated moving averages dip below longer-dated ones — signals potential further declines. A break below the October 2023 low of $1.0448 could push the euro to its weakest level in two years.

Multiple macro and political challenges continue to weigh on the euro. Trade and tariff risks tied to Trump’s policy agenda, political instability in France and Germany, and the escalating conflict in Ukraine have all dampened sentiment. Investors seeking safe-haven assets have driven demand for German bunds, causing yields to slide across the curve. Additionally, weak Eurozone economic indicators, including today’s flash PMIs, are expected to disappoint, reinforcing the European Central Bank’s (ECB) dovish policy stance.

The bearish sentiment extends to the options market, where traders are paying a premium for puts betting on further EUR/USD declines compared to calls anticipating gains. Implied volatility on the euro has surged to its highest level since the U.S. election, underscoring the heightened uncertainty amid the ongoing selloff.

Dollar Gains Amid Fed Speculation and Geopolitical Tensions

Traders are closely watching for details on Trump’s policy agenda while scaling back expectations for aggressive Federal Reserve rate cuts. Comments from Fed policymakers this week offered little clarity, but the odds of a 25-basis-point rate cut next month have dropped significantly, now at 40%, down from 83% last week.

Geopolitical developments, particularly the escalating Russia-Ukraine conflict, have further boosted the dollar’s safe-haven appeal. The greenback continues to strengthen against the euro and sterling, though it faces resistance from the similarly safe-haven Japanese yen.

On the macroeconomic front, U.S. unemployment benefit applications unexpectedly fell last week to their lowest level since April, signalling a robust labour market. However, continuing claims — a measure of ongoing unemployment — rose to 1.91 million, the highest in three years. Meanwhile, a recession indicator derived from Federal Reserve regional indexes is declining, suggesting an increased likelihood of a "soft landing" or no recession scenario, reinforcing the narrative of U.S. economic resilience.

Euro Slides to $1.05 Amid Rising Risks and Market Uncertainty

The euro has sharply declined to $1.05 against the US dollar at inter-bank (IB), losing nearly 1% due to escalating geopolitical tensions, trade risks, and widening interest rate differentials that weigh against the euro. This drop comes despite a significant surge in Eurozone wages, which complicates the European Central Bank's (ECB) plans to ease monetary policy as inflation slows.

Eurozone third-quarter negotiated pay increased by 5.4% year-on-year, up from 3.5% in the prior quarter, with Germany driving much of the growth. While wage growth signals persistent inflationary pressures—a key focus for the ECB—a weakened economic outlook and reduced corporate pricing power are likely to keep the easing cycle on track. Investors are pricing in a 139-basis-point rate cut by the ECB by the end of 2025, but ECB officials have downplayed the likelihood of aggressive monetary easing, pointing to increased volatility in euro interest rates heading into 2024.

In the foreign exchange (FX) options market, traders are increasingly positioning for a weaker euro as the currency hovers near its 2024 low. A sustained breach below the $1.05 mark at IB could pave the way for a decline to $1.03 at IB, a key downside target, particularly under the scenario of a "Red Sweep" in US elections. Geopolitical factors, such as a potential escalation in the Russia-Ukraine conflict, could add further downward pressure to the euro, exacerbating its vulnerabilities in the global economic landscape.

Sterling Slumps Against the Dollar but Holds Gains Versus the Euro

The British pound has erased all its post-inflation gains against the US dollar, sliding into negative territory for the year and dropping over 2% month-to-date. Currently trading about two cents below its five-year average, GBP/USD has fallen significantly from being six cents above this level less than two months ago—a shift attributed to the "Trump effect." In contrast, GBP/EUR has reclaimed the €1.20 mark at IB, rising over 4% year-to-date and sitting five cents above its five-year average.

The bullish outlook for sterling, driven by cyclical factors since early 2024, may persist into 2025 if UK economic data remains strong and inflation continues to outpace expectations. This scenario could prompt the Bank of England (BoE) to delay rate cuts. However, uncertainty looms as the October UK Budget introduces a new fiscal-monetary policy mix. While initially supportive for the pound, concerns are growing over the potential for tax hikes to dampen consumption and economic growth. If UK economic performance falters, sterling could face renewed pressure. Flash industry PMIs, due tomorrow, will provide further insight into the economy's health as 2024 draws to a close.

For the BoE, no rate changes are expected in December, with the central bank likely to maintain its gradual pace of rate cuts, interpreted as one reduction per quarter. With markets currently pricing in only 60 basis points of cuts by the end of 2025, there is room for traders to adjust their expectations, potentially leading to further downward corrections for sterling.

Dollar Strengthens Amid US Exceptionalism Narrative but Faces December Headwinds

Russia’s revision of its nuclear doctrine initially triggered a surge in safe-haven demand, but investor focus quickly shifted back to the US economy. Recent better-than-expected economic data, combined with a Republican sweep of the presidential and congressional elections, have bolstered the narrative of US exceptionalism. This economic resilience and upward revisions to GDP forecasts contributed to significant dollar gains in 2024, a trend that may continue into early 2025.

Despite the dollar’s momentum, uncertainties remain. Key questions include the timing and impact of fiscal and tariff policy changes, how global peers might respond, and whether upcoming US data will continue to confirm economic outperformance. Additionally, December’s historically weak seasonality for the dollar could present a window for other currencies to recover some lost ground.

Sterling Surges Amid Strong UK Inflation Data  

Sterling climbed above $1.27 at inter-bank (IB) against the US dollar and €1.20 at IB against the euro this morning, buoyed by unexpectedly high UK inflation figures. The data adds pressure on the Bank of England (BoE) to postpone further interest rate cuts until next year, enhancing the pound's yield appeal.  

Annual headline CPI increased to 2.3% in October, surpassing the forecast of 2.2% and up from 1.7% in September. The rise was driven largely by higher housing and household services costs, particularly electricity and gas prices, following the 10% hike in the UK energy price cap for October. This marked the largest monthly inflation jump since October 2022. Core inflation also exceeded expectations at 3.3%, while services inflation edged back to 5%, consistent with BoE forecasts.  

Despite cutting interest rates twice to 4.75%, the BoE is now expected to delay further reductions. A 25-basis-point cut initially anticipated in December is now projected for February, with markets pricing the next full cut for March. Investor expectations for cumulative easing through 2025 have been reduced, with 59 basis points now priced in, down from nearly 67 yesterday.  

While stretched speculative bullish positions may pose downside risks to sterling, today's inflation report could fuel further short-term gains for the pound.

Geopolitical Tensions Spark Shift to Safe Havens  

Renewed tensions between Russia and the US triggered volatility across financial markets yesterday, driving investors toward safe-haven assets. Treasury bonds, gold, the US dollar, Swiss franc, and Japanese yen all gained, while the Polish zloty suffered the steepest losses due to its geographical proximity to the conflict.  

The resurgence of geopolitical risks followed updates to Russia’s nuclear doctrine and reports of a Ukrainian missile strike within Russian territory. Russia has warned that Ukraine's use of Western-supplied non-nuclear missiles against Russian targets could provoke a nuclear response, heightening fears of escalation.

Limited Upside for EUR/USD Amid Persistent Headwinds  

Despite a brief reprieve from selling pressure, the euro lacks a strong foundation for a significant recovery against the US dollar. Weak economic conditions in the Eurozone, political uncertainties, trade tariff risks, and widening interest rate differentials continue to weigh on the currency, suggesting sustained weakness in the medium term.  

Since Trump’s re-election, EUR/USD has declined over 3%, and the drop extends to over 6% since the end of September. The $1.05 level remains a critical psychological support, but further downside appears likely without clear policy actions from the new administration. Trade tariffs pose a significant risk for EUR/USD volatility, while widening rate divergence is expected to sustain downward pressure on the pair.  

Although potential stimulus measures from China could lend support to the euro, current policy announcements have underwhelmed, leaving little room for optimism about a reversal in EUR/USD's downward trend.