USD

The dollar index edged higher after Federal Reserve Chair Jerome Powell reiterated that the path for interest rate reductions is not straightforward. He highlighted the challenge of keeping inflation contained while the labour market shows signs of slowing. In parallel, newly appointed Governor Stephen Miran, who had pushed for a larger 50 bp reduction last week, warned that misjudging how restrictive policy is could risk job losses if the Fed fails to act boldly enough.

Economic indicators gave a mixed signal. US PMIs fell short of expectations, with the composite index slipping from 54.6 to 53.6 (consensus: 54). Employment held at 51.7 and new orders at 53.1, both still pointing to expansion. Input costs rose but output prices eased, suggesting pressure on margins. These figures were not sufficiently weak to alter the market view in any meaningful way. Following Powell’s remarks, investors have scaled back bets on two more cuts this year, allowing the dollar to regain some ground.

What is emerging is a shift in the narrative. Rather than being defined by falling interest rates, the dollar is increasingly seen through the lens of relative US growth. After a substantial decline in the second half of last year, expectations now centre on a terminal rate near 3%. While growth momentum has slowed from its pandemic peaks, tariff volatility has cooled, financial conditions remain loose, and fiscal support is increasing through the so-called “One Big Beautiful Bill”. This combination could position US growth more favourably in 2026.

GBP

The UK economy’s momentum faltered in September, with the latest PMI survey signalling the sharpest slowdown in private-sector activity since April. Services growth softened and manufacturing contracted more steeply, dragging the composite index down from a one-year high to a four-month low. Sterling initially fell to an eight-week trough against the euro before staging a mild recovery. Against the dollar, it held just above $1.35 – a threshold it has only rarely surpassed in the past decade.

Britain’s domestic picture has darkened relative to early 2025. Softer data and fiscal concerns are weighing heavily, leaving sterling more dependent on continued dollar softness. Rate differentials remain key: the correlation between UK and US two-year yields with GBP/USD has strengthened again, with the spread widening to a two-year high of 46 bps, helping the pound retain an 8% year-to-date gain. Yet fiscal risks present a fragile backdrop. Markets remain wary of rising debt burdens, and sterling options show strong demand for downside cover into year-end.

The OECD’s outlook compounds this caution, forecasting only 1.0% GDP growth for the UK in 2026. After two years of outperformance in 2023 and 2024, both sterling and the economy have lost ground in 2025. The government faces a budget shortfall of roughly £30 billion, likely to be plugged with higher taxes rather than spending restraint. This persistent uncertainty undermines investment and weighs on sentiment. Sterling’s gains versus the dollar this year largely reflect US weakness, and even then they lag behind European peers such as the Swedish krona and Swiss franc.

EUR

The euro held steady just below $1.18, with traders reluctant to push higher without clearer guidance from the Fed. While a short-term move above $1.18 cannot be ruled out, holding this ground would require a stronger shift in US policy signals.

Eurozone PMIs painted a divided picture. Manufacturing slipped to 49.5 against forecasts of 50.7, signalling contraction, but services proved resilient, keeping the composite index at 51.2. The service sector’s strength is helping offset manufacturing weakness, yet it highlights ongoing fragility, particularly given the reliance of the bloc’s exporters on a tariff-laden global trade environment.

Attention now turns to US PCE data due Friday. A softer-than-expected result could give the euro a brief lift through the $1.18 level. Still, with the Fed maintaining a cautious and inconsistent tone, any rally may prove fleeting.

Looking ahead

Currency markets are entering a period where relative growth dynamics and fiscal backdrops matter as much as central bank expectations. The dollar appears to be carving out a floor as growth resilience challenges the market’s bearish stance. Sterling’s fortunes rest heavily on November’s budget and whether fiscal clarity can restore investor confidence. For the euro, modest service-sector strength offers support, but global trade conditions and the Fed’s next moves will dictate near-term direction.