Monfor Weekly Update

The Pound Sterling surged on Monday, achieving its best exchange rates for Euro buyers in 34 months. This upward momentum began late on Friday due to a strong U.S. job report that reduced the likelihood of U.S. interest rate cuts. This development also lessened the chances of UK rate cuts, as markets speculated that the Bank of England would follow the Fed in postponing the start of a rate-cutting cycle, boosting UK bond yields and the Pound.

The GBP/EUR price action indicates that the rally is driven by external factors. Performance data shows that the Pound has significantly benefited from the reassessment of U.S. interest rate expectations, appreciating against all G10 currencies except the Dollar. Meanwhile, the Euro has steadily weakened following the European Central Bank's decision to cut interest rates last week.

If regular wages exceed the expected 6.1%, the Pound could rally further, suggesting that the Bank of England's Monetary Policy Committee (MPC) might be cautious about raising interest rates in August to avoid reigniting domestic inflation. Additionally, the UK GDP report due on Thursday is crucial, with markets expecting a 0.1% month-on-month rise for April and a 0.7% year-on-year increase. Any deviation from these expectations could lead to the Pound giving up some of its recent gains.

The GBP/USD exchange rate has been more subdued due to strong U.S. jobs data. The Pound dropped half a percent against the Dollar after U.S. non-farm payrolls rose to 272k in May from 170k in April, surpassing the expected 180k. Average hourly earnings increased to 4.1% year-on-year in May, up from 3.9% in April, exceeding the anticipated 3.9%.

It's a quiet week in the Eurozone, with no major events on the calendar outside of the snap election called by President Macron in France. In the UK, the headline data release is the GDP report on Wednesday, with expectations of a flat result for April. However, the most critical events will be the Fed interest rate decision and the FOMC statement on Wednesday afternoon. Additionally, the US CPI is due on Wednesday, which could introduce some volatility mid-week.

 

ECB not committed to cutting again

The European Central Bank (ECB) has followed the Bank of Canada as the second major central bank to reduce interest rates this week, lowering its main refinancing rate by 25 basis points to 4.25% overnight.

In an unusual move, the ECB raised its inflation forecasts for 2025 from 2.0% to 2.2%. This adjustment led the central bank to be more cautious about indicating further rate cuts, as higher inflation forecasts typically make additional rate reductions less likely.

Due to the lack of strong signals for future cuts, the euro appreciated following the announcement, with the EUR/USD exchange rate increasing by 0.2%.

Tonight, the spotlight is on the crucial US jobs report. Financial markets are still unsettled after last month’s report missed forecasts for the first time in seven months, compounded by other weakening US labor market data, such as Tuesday’s JOLTS report.

According to Refinitiv, markets are anticipating 185,000 new jobs, up from last month’s 175,000, with the unemployment rate expected to remain steady at 3.9%.

However, another weak number could have a significant impact, potentially causing the USD index to break below support at 104.00, reaching its lowest level since mid-March.

ECB Looms

The Pound Sterling reached its highest level against the Euro in 21 months on Wednesday, closing at 1.1759. This marks the highest daily finish since August 2022, driven by a recovery in global equity markets, which typically benefits the risk-sensitive Pound.

However, the Pound faces potential challenges today due to the European Central Bank's (ECB) decision. Euro exchange rates will be under scrutiny as the ECB cuts interest rates and provides guidance on the timing of the next cut. While the June cut has been anticipated for weeks, the focus for currency markets will be on when the subsequent cut might occur.

Markets indicate low odds of the ECB delivering a follow-up rate cut in July, as a recent rise in inflation is expected to prompt the ECB's Governing Council to proceed cautiously.  The concern is that cutting rates too quickly and too significantly could exacerbate inflationary pressures.  ECB President Christine Lagarde might express concerns about inflation while acknowledging that the Eurozone's economy has shown improvement since the last meeting.

 

Risk aversion could mute further GBP upside

On Tuesday, the risk-sensitive pound was influenced by renewed global risk aversion as investors sought safety in traditional safe-haven currencies like the US dollar, Japanese yen, and Swiss franc. This shift was triggered by the surprising outcome of India's election, where Narendra Modi lost his parliamentary majority.

Markets had anticipated a landslide victory as predicted by exit polls, but this result highlighted the unreliability of polls. The election outcome was much closer than expected, and the resulting coalition government spurred a wave of demand for safe-haven assets, boosting the Japanese yen. The yen was further supported by hawkish remarks from a Bank of Japan (BoJ) official, who hinted at scaling back bond purchases in the upcoming meeting this month. This led to a bullish shift in yen risk reversals across several tenors, indicating the strongest positive sentiment in weeks. As a result, USD/JPY fell to two-week lows, while GBP/JPY and EUR/JPY experienced their largest daily drops in over a month, with the former falling from ¥200 to nearly ¥197. Although the yen has since given up most of these gains, increasing volatility suggests potential for further strengthening amidst divergent monetary policies and political developments.

These recent political and monetary policy surprises underscore the sensitivity of certain currencies. Significant fluctuations can occur rapidly, especially with the yen. The British pound, also a risk-sensitive currency, is susceptible to substantial swings, particularly periods of weakness during heightened risk aversion. This is crucial to consider with upcoming central bank meetings and elections in Europe, the UK, and the US.

The euro depreciated for the first time since last Wednesday as risk-off safe-haven flows dominated the markets. German unemployment claims unexpectedly rose by 25,000, compared to the anticipated 10,000, while the unemployment rate remained steady at 5.9%. Despite this, investors have reduced their expectations for European Central Bank (ECB) policy easing this year, primarily due to the surprising inflation increases over the past two months. The inflation uptick in May led some policymakers to adopt a more hawkish stance, casting doubt on the likelihood of consecutive rate cuts in July.

Some central bankers, particularly from Germany, appear to have ruled out policy easing at the July meeting. However, ECB pricing still tends to follow the Federal Reserve. This means that a potential downturn in the US economy and the end of US exceptionalism could reintroduce some of the rate cuts that were previously priced out. Despite the recent depreciation, the euro is still on track to appreciate for seven out of the last eight weeks, influenced by last week’s persistent inflation report.

EUR/USD is holding above the $1.0880 level, but momentum will need to be confirmed by today's US ISM PMI data and Thursday’s ECB rate decision. Any significant positioning is likely to be cautious and limited ahead of the US labour market report on Friday.

USD in the headlights after lacklustre performance

The US dollar has weakened against most G10 currencies. GBP/USD has reached fresh 12-week highs above $1.28, while EUR/USD has reclaimed $1.09 for the first time since mid-March. This dollar weakness is due to declining yields following the US ISM manufacturing PMI report, which confirmed trends of slowing growth, decelerating inflation, and a tight labour market. Investors are closely monitoring data to assess how long the narrative of US exceptionalism can persist. The nonfarm payrolls report on Friday will be a critical event for cross-asset developments. Yesterday, the US manufacturing PMI surprised markets with a decline from 49.2 to 48.7 in May, impacting the US currency. Notably, the employment category showed improvement after seven months of contraction. JOLTS job openings will be important today, followed by services PMI on Wednesday and the eagerly anticipated jobs report on Friday

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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