GBP: Short covering supports sterling but structural risks linger

UK GDP edged up by 0.1 percent in August, precisely matching expectations, supported by a modest recovery in manufacturing. This return to growth places the economy on track for a small expansion in the third quarter. The figures offer some relief, even though earlier data continue to reflect a subdued labour market. The numbers are being interpreted through the lens of the forthcoming autumn budget, which represents a persistent headwind for sterling. Anticipated tax increases for both businesses and households are likely to weigh on confidence, growth prospects and the currency’s overall appeal.

Sterling has nevertheless delivered a strong performance against its G10 counterparts this week. The recent build-up of speculative short positions has made the currency vulnerable to short covering, even when the data is not particularly impressive, provided it is not dramatically weak. Labour market indicators point to a more moderate slowdown than many had feared, with easing wage growth matched by relatively contained declines in payrolled employment.

This combination has helped the pound hold its ground despite an unremarkable run of data. In the options market, risk reversals remain tilted towards sterling puts, indicating that investors continue to seek protection against further weakness rather than positioning for strength.

Sterling began the year under the weight of a recurring fiscal risk premium that tends to resurface during both the spring and autumn budget cycles. Unlike changes in interest rates, this type of risk is difficult to fully incorporate into market pricing. As a result, periodic short squeezes remain a familiar feature of sterling trading, maintaining a broadly bearish undertone that has been evident once again this week.

USD: Momentum slows above 99

The dollar lost some momentum, slipping back below the 99 level. This was largely anticipated as improved political and economic sentiment in France and Japan dragged the DXY index lower through their substantial weighting. The move was not driven by any particularly positive catalyst for the dollar, but rather by a gradual easing of downward pressures combined with reduced market anxiety over recent political uncertainty.

The currency weakened more broadly yesterday, first following Powell’s dovish comments, then more decisively after the release of the Beige Book. This collection of economic anecdotes reinforced the perception that the Federal Reserve remains open to further interest rate reductions as economic activity shows clearer signs of slowing.

Markets appear to have largely set aside trade concerns for the time being. The planned meeting between the two national leaders is still expected to take place, with hopes building for constructive discussions. This gathering will occur just days before a one hundred percent tariff on Chinese imports is due to be implemented on 1 November, following Trump’s early October announcement. Scott Bessent has reportedly suggested another potential truce with China, possibly of longer duration, in return for Beijing shelving its proposed new export restrictions on rare earth materials.

The dollar may find it difficult to maintain a position above the 99 threshold in the near term, as further gains increasingly depend on its own fundamentals rather than weakness elsewhere. Although the Federal Reserve reduced rates in September and may act again later this year, the expected easing path, coupled with more measured forward guidance since Trump’s second term began, is likely to keep any significant dollar weakness in check.

Large US banks have had a very strong week, reporting third quarter results that exceeded expectations by a wide margin. In the absence of major new data releases, this performance has highlighted underlying economic resilience and calmed some trade-related concerns.

For today, attention turns to rate-setters. Bowman’s cautious but well-reasoned tone is expected to contrast with Waller’s more familiar labour market warnings, with little meaningful dollar movement likely during this quiet data period.

EUR: Data disappointments continue to mount

Economic data from the euro area remains lacklustre. Industrial production across the bloc fell by 1.2 percent in August on a monthly basis, reversing July’s modest 0.3 percent increase and marking the weakest reading since January. This contrasts with earlier PMI surveys that had hinted at a more positive trend. At the current pace, manufacturing looks set to detract from third quarter eurozone growth.

This ongoing weakness is unlikely to shift expectations around further European Central Bank rate reductions. The ECB has made clear that it places greater emphasis on inflation developments than on short-term cyclical fluctuations in output. Nevertheless, the evidence is accumulating and could become more influential if inflation softens more persistently than anticipated.

With few immediate catalysts favouring the dollar, the euro is likely to remain comfortably above the recently retested 1.1550 support level, with a gradual move towards 1.17 remaining plausible. French Prime Minister Lecornu faces confidence votes today that are expected to pass, which may help the euro advance further against the dollar. Should the Federal Reserve continue to signal a more dovish stance, we see EUR/USD finding comfort around 1.18. This suggests that the current gap between spot and that level reflects sentiment rather than fundamentals, and it is likely to narrow as the French political situation stabilises.