EUR: Lagarde holds as Germany falters

It was a busy session for the euro area yesterday, though markets largely shrugged off the domestic developments. The European Central Bank kept interest rates unchanged, exactly as expected, while data confirmed broadly solid GDP growth across the region in the third quarter. France, the Netherlands and the eurozone aggregate all exceeded forecasts, painting a picture of resilience despite persistent political and structural challenges. The clear laggard remained Germany, which narrowly avoided a technical recession. Growth was flat in the third quarter following a slightly upward revision to the previous quarter’s contraction, from 0.3 to 0.2 per cent. The figures highlight how Europe’s largest economy continues to struggle to translate policy support and fiscal commitments into tangible output gains.

Elsewhere, European Commission sentiment surveys surprised positively, adding to a cautiously optimistic tone. Yet the single currency’s response was limited. The euro slipped below 1.16 as traders in New York took fresh cues from dollar-supportive headlines. Once again, euro-specific data and policy developments failed to meaningfully shift the currency’s direction.

At the ECB press conference, President Christine Lagarde reiterated the view that policy settings are broadly appropriate. The Bank left rates unchanged for a third consecutive meeting, and the tone remained consistent with a data-dependent, meeting-by-meeting approach. Lagarde noted that inflation prospects have not materially changed and that both upside and downside risks remain. The message was one of steady hands rather than new commitments.

The euro’s attempt to hold above 1.16 underlines the dilemma created by the Federal Reserve’s cautious stance. A still-solid US economy continues to lend support to the dollar, while the Fed’s more measured language prevents markets from turning decisively dovish. In this environment, the euro finds itself constrained on both sides. Without a clear deterioration in US data, the case for meaningful euro appreciation remains limited.

GBP: Sterling shaken by rate cut fears and fiscal uncertainty

The pound is heading for its weakest weekly performance since early January, weighed down by rising expectations that the Bank of England will resume cutting interest rates before the end of the year. Markets now assign better than even odds to a 25-basis-point cut in December, compared with just one in five a month ago. Two cuts are fully priced by mid-2026. The shift reflects growing conviction that the UK will ease policy faster than most of its peers, with six-month implied rates falling by around 4.5 per cent this quarter — one of the steepest declines across the G10. In contrast, expectations for Norway and Sweden have moved higher, eroding sterling’s relative yield advantage.

Lower gilt yields may offer the Treasury some breathing room, but they have also stripped the pound of one of its key sources of support. The BoE’s expected pivot towards easier policy stands in sharp contrast to a Federal Reserve that remains cautious and a European Central Bank that continues to hold steady. Sterling has been moving in lockstep with rate differentials, and it now trades close to its weakest level since May against the dollar and near a two-year low versus the euro.

Fiscal concerns are adding to the gloom. Investors are bracing for tax increases and spending restraint in next month’s Budget as the government attempts to close a widening fiscal gap. Reports that a two-pence increase in the basic rate of income tax is under discussion followed Prime Minister Sir Keir Starmer’s decision not to repeat Labour’s campaign pledge to avoid rises in income tax, National Insurance, or VAT. The move may prove politically costly, but markets are likely to view it as necessary to preserve fiscal credibility.

For a government unwilling to make deep cuts to welfare spending, higher taxation was always the most plausible route to reassure investors. Even so, the combination of monetary easing expectations, fiscal tightening and softening economic data has created a toxic mix for the currency. For now, sterling remains vulnerable to further weakness unless either the Bank of England or the Chancellor manages to restore confidence in the UK’s medium-term outlook.

USD: Dollar edges higher into month-end

The US dollar index is on course for its second monthly gain of 2025, supported by firm economic data, cautious optimism over trade negotiations and a Federal Reserve that remains broadly hawkish in tone. Options markets show a modest build-up of fresh long positions, though overall sentiment remains balanced rather than excessive. The question now is whether the dollar’s latest advance can extend beyond the end-of-month flow distortions that often characterise this period. Portfolio rebalancing, benchmark tracking and liquidity adjustments frequently combine at month-end to amplify short-term volatility.

The dollar’s recent performance also reflects an improvement in risk sentiment, aided by progress in trade discussions between the United States and China. The temporary easing of geopolitical tensions has encouraged renewed flows into US assets. However, the dollar’s strength has not been driven solely by monetary policy expectations. During the Asian and European sessions, the greenback was largely steady, even drifting lower, before gathering momentum in New York trading. The move coincided with a jump in Treasury yields following a surprise 25-billion-dollar bond issue by Meta, which lifted longer-term yields and underpinned the dollar.

From a technical perspective, the dollar index continues to face longer-term resistance, with the 200-day moving average still trending lower. Nevertheless, it has convincingly regained its 21-day moving average this month and is now approaching the 100 level. A close above this threshold would suggest that the current rally has substance. Support near 96 has remained intact throughout the year, aligning with a slow but steady upward trendline that has been in place since 2010.

In essence, the dollar’s resilience rests on a combination of solid fundamentals and tactical positioning. Although longer-term challenges remain, particularly if the US economy slows or the Fed shifts decisively towards easing, for now the greenback retains the upper hand.