UK economy beats expectations, lifting pound outlook

Recent figures show the UK economy made a much stronger start to 2024 than forecast, with GDP expanding by 0.7 percent in the first quarter. This marks a clear improvement from the modest 0.1 percent growth seen at the end of last year. March contributed a further 0.2 percent rise, and exports climbed to their highest level in two years. However, this data does not yet reflect the potential effects of the recent Liberation Day tariffs.

The labour market presents a more complex picture. Wage growth remains elevated at 5.6 percent on an annual basis, although it appears to be flattening. This is raising concerns about whether such pay increases are sustainable for employers. The employment rate stayed at 75.0 percent, while unemployment inched up to 4.5 percent. This points to ongoing difficulties in recruitment. Job vacancies continued to decline, falling to 761,000 and maintaining a steady downward trend.

The combination of robust economic growth and persistent wage pressure could lead the Bank of England to hold off on cutting interest rates. Market expectations have now shifted, with August seen as the most likely month for any change in policy.

Turning to the pound, market sentiment has turned increasingly optimistic. Bullish positions on sterling have reached their highest level in five years, with one-month GBP/USD risk reversals showing rising demand for the pound. Options pricing suggests traders are growing more confident. Speculation that Donald Trump may support a weaker US dollar has pushed one-year GBP/USD risk reversals to levels last seen in 2009.

Sterling could find additional support from next week’s UK-EU summit. New economic measures are expected to be announced, and if these are seen as supportive of future growth, they may influence expectations around monetary policy and add further momentum to the pound.

Pound outlook shaped by EU-UK negotiations and investor confidence

The near-term performance of the Pound against the Euro is likely to be influenced by the outcome of upcoming EU-UK talks. Discussions are expected to cover key areas such as security, youth mobility, and trade. Any meaningful agreement could support further gains in Sterling, which has already benefited from expectations of progress. However, recent media reports suggest there is a risk of disappointment early next week.

Several contentious issues remain unresolved. These include EU access to UK fishing waters and the potential reinstatement of free movement for under-30s. Both are politically sensitive topics, especially given the current scrutiny of immigration and the pressure on Keir Starmer to deliver credible policy solutions. If the negotiations result in a limited agreement focusing only on defence cooperation, financial markets may view the outcome as underwhelming. This could see GBP/EUR slip below 1.19 and move towards the lower 1.18 range.

In the short run, the outcome of these talks is likely to dominate market focus. However, the broader direction of the currency pair will depend more heavily on changes in global investor sentiment. So far, improved confidence has helped keep the Pound relatively resilient.

Sterling continues to reflect trends in equity markets and was hit hard in April when volatility spiked following Donald Trump’s early-month tariff announcements. Since mid-April, calmer conditions have allowed GBP/EUR to recover gradually.

Some analysts believe that much of the positive news may already be reflected in prices, especially following the temporary easing of trade tensions between the United States and China. Even so, uncertainty surrounding future trade policies continues to hold back spending and investment decisions. This has also cast doubt on the likelihood of early rate cuts by the Federal Reserve.

Should global sentiment deteriorate, the Euro may start to attract more support. Fiscal policy developments in the United States could also influence this dynamic. Reports suggest Republican lawmakers are considering a significant debt ceiling increase, potentially adding $4 trillion in borrowing through a new budget reconciliation package. This could push the federal deficit close to 6.5 percent of GDP in the coming years. If international investors are reluctant to absorb this additional debt, market instability may follow, weakening risk sentiment and putting pressure on Sterling.

For now, this remains a secondary risk. Provided equity markets continue to perform and U.S. data does not signal an imminent downturn, the most likely path for GBP/EUR remains higher, with a sustained move above 1.19 still expected.

Weak US data puts pressure on the dollar as economic momentum fades

The dollar came under renewed pressure towards the end of the week following a disappointing batch of US economic figures. April’s retail sales report pointed to a slowdown in consumer activity, suggesting that the surge in March spending, likely driven by early purchases ahead of anticipated tariffs, has now run its course. At the same time, figures on producer prices indicated subdued inflationary pressures, hinting that firms may be absorbing rising costs, although this may not be sustainable over time.

Headline retail sales in April edged up by just 0.1 percent, with the majority of spending categories recording declines. This highlights a broader weakening in household demand. In addition, producer prices fell by the largest margin in five years, offering further evidence of softening price pressures. The data points to only a slight 0.1 percent monthly rise in the Federal Reserve’s preferred inflation measure, the core PCE deflator. However, previous readings on producer prices have been revised higher, creating some uncertainty around the trend.

Elsewhere, regional business surveys painted a mixed picture. The New York and Philadelphia Federal Reserve reports indicated that business conditions had worsened overall, although both noted an increase in new orders. Despite the expectation of higher raw material costs in the months ahead, this rise in demand suggests that the national ISM manufacturing PMI could see a modest improvement in May.

Dollar rally falters as trade tensions ease but uncertainty persists

The temporary easing of US-China trade tensions has brought a measure of relief to global markets. A 90-day pause in tariff escalation has marked a turning point in the trade dispute’s most volatile phase, encouraging risk-taking and prompting a rise in US Treasury yields as investors unwind positions in safer assets. However, the US dollar’s initial bounce has quickly faded, weighed down by renewed speculation that President Donald Trump may be leaning towards a weaker currency stance.

Although the dollar initially benefited from improved market sentiment, its momentum has not been sustained. Investor caution remains high, with unresolved concerns over the broader economic fallout from the protracted trade conflict. In the absence of convincing signs of recovery, appetite for further dollar appreciation is limited. Short-term bond yields have inched higher, as expectations for interest rate cuts from the Federal Reserve have softened—markets are now pricing in under 50 basis points of easing for the rest of the year. Even so, longer-dated Treasuries remain susceptible, as US fiscal policy pivots towards tax relief without addressing deficit concerns, which continues to exert upward pressure on yields and downwards drag on the greenback.

Recent US-South Korea trade discussions have reignited speculation that the Trump administration may actively prefer a weaker dollar, potentially nudging other countries to allow their currencies to strengthen during trade negotiations. Historically, a weaker dollar has helped Asian exporters, a dynamic Washington is increasingly eager to counter.

In essence, while the near-term reprieve in dollar pressure is evident, deeper challenges endure. Market participants are watching closely for economic indicators that could confirm whether the earlier strains from the trade war are beginning to filter through. Notably, in currency options markets, sentiment towards the dollar over a one-year horizon is now at its most negative in five years—a clear sign of ongoing unease. With US retail sales figures due out today, traders will be searching for new clues on where the dollar and broader markets may head next.

Pound lifts as UK growth surprises and rate cut expectations shift

The British pound firmed slightly following the release of GDP figures that outpaced forecasts, signalling unexpected resilience in the UK economy. Growth in the first quarter reached 0.7%, exceeding the anticipated 0.6% and significantly improving on the previous quarter’s modest 0.1% expansion. Notably, March recorded a 0.2% rise, outperforming expectations for flat growth and underscoring a steady pickup in momentum. Exports were particularly strong, marking their highest performance in more than two years—though it’s worth noting the figures precede the introduction of “Liberation Day” tariffs.

This upbeat economic snapshot, combined with the persistent wage pressures highlighted in this week’s labour market report, strengthens the case for the Bank of England to maintain its current policy stance for now. Market participants have largely priced out a rate cut at the BoE’s June meeting. Still, attention is shifting to August as a likely window for action, keeping investors attuned to any adjustments in the Bank’s forward guidance.

Euro steadies as softer dollar and policy signals guide markets

In the near term, the euro remains largely at the mercy of external developments. The single currency reclaimed the $1.12 mark yesterday, lifted by a weaker US dollar following a surprise dip in American inflation data and renewed uncertainty around US-China trade relations—even with a temporary 90-day pause in tariffs. Still, EUR/USD continues to trade roughly four cents below its 2025 high, and a meaningful push higher appears unlikely unless the pair can close decisively above its 21-day moving average, currently at $1.1314.

On the economic front, the latest ZEW expectations survey for the Eurozone delivered a more upbeat outlook for May, hinting at improving sentiment around political stability and international trade. However, the accompanying assessment of current conditions remained subdued, underscoring ongoing fragility in the region’s recovery. Market attention now turns to today’s industrial production figures, which could help clarify whether the area is on firmer footing or still grappling with persistent headwinds.

Shifting expectations around European Central Bank policy have also shaped market dynamics. Investors now see the deposit rate ending the year at 1.71%, a modest rise from last week but still below the levels implied in April. A rate cut in June is now seen as highly probable, with odds nearing 85%, as officials attempt to shield the economy from the potential fallout of US trade actions. Commentary from ECB policymakers has been mixed—François Villeroy de Galhau suggested another rate cut could be in play by summer, while Joachim Nagel expressed confidence that inflation is moving closer to the Bank’s 2% goal.

Sterling stages a comeback on weaker Dollar and renewed risk appetite

The pound has staged a notable recovery, climbing back above $1.33 after slipping below $1.32 earlier in the week. This rebound followed lower-than-forecast US inflation data, which weighed on the dollar and allowed sterling to reclaim ground. GBP/USD is now eyeing its 21-day moving average, a move that may reinforce the currency’s upward trajectory since its January low near $1.21. A string of further disappointments in US economic data could offer sterling additional momentum, building on its 6% rise since the start of the year.

Against the euro, the pound also gained ground, with GBP/EUR briefly pushing through the €1.19 level. Diminished market volatility and an upswing in global risk sentiment have favoured the pound, which tends to perform better in such conditions due to its higher sensitivity to risk. A sustained risk-on environment could propel GBP/EUR further, but key resistance levels remain, including the 200-day moving average at €1.1925. Clearing these technical barriers would strengthen the case for a return towards the €1.20 mark.

Although UK economic growth is still on shaky ground, fears of a recession are beginning to ease. The Bank of England, for its part, has maintained a measured tone, steering clear of any abrupt policy pivots. Should currency markets begin to re-centre their focus on interest rate differentials, the yield gap between the UK and the eurozone could continue to support sterling. Moreover, the recent US-UK trade agreement, which grants Britain some breathing room on tariffs, has offered a further boost to investor sentiment toward the pound.

Signs of cooling in US inflation stir hopes for Fed policy shift

US consumer prices showed a smaller-than-expected increase in April, with the monthly rise limited to just 0.2%. This pulled annual headline inflation down to 2.3% – the lowest level since early 2021. Core inflation, which excludes more volatile components, held steady at 2.8%. The overall picture suggests diminishing inflationary pressures, with businesses so far showing little inclination to pass higher import tariffs onto consumers.

Given that services comprise the bulk of the US inflation basket, tariffs affecting goods – which account for under 20% of the index – are having a muted effect, at least for now. Softer trends in housing and service prices are also helping to contain broader inflation. This was echoed in the latest NFIB small business survey, which highlighted a fall in the number of firms planning price hikes, further reinforcing the idea that inflation could continue to moderate. While the full effect of recent tariffs may not yet be visible, the softer inflation trajectory is fuelling speculation that the Federal Reserve could begin cutting interest rates sooner than previously expected.

The US dollar, meanwhile, has pulled back after hitting resistance at its 50-week moving average, suggesting that the recent rally may be running out of steam. Yet higher Treasury yields point to lingering investor caution, as markets await clearer evidence on how tariffs will affect inflation through the summer months. The Fed’s patient stance has helped keep the dollar supported via the yield channel, but this could quickly reverse if upcoming data shows further weakening in core inflation.

Euro finds its footing as confidence in German outlook climbs

The euro has regained ground, trading just below the $1.12 level, after rebounding from a sharp 1.5% slide earlier in the week. The recovery was driven by a combination of upbeat German economic sentiment and a weaker-than-anticipated reading on US inflation, prompting investors to reassess the euro’s short-term prospects.

Germany’s ZEW Economic Sentiment Index delivered a striking improvement in May, leaping to 25.2 from April’s deeply negative -14 and comfortably beating market forecasts. The jump reflects rising optimism around economic stabilisation, government clarity, and progress on trade matters. Nearly 30% of surveyed analysts now anticipate a pick-up in economic activity, as inflation appears more contained and the outlook for tariffs softens. While the European Union remains locked in negotiations with the US administration, contingency plans are in place for retaliatory measures covering €95 billion in American goods if diplomacy falters.

From a technical perspective, the EUR/USD pair has found support near its 50-day moving average, while momentum signals—such as the 14-day relative strength index—hover close to neutral territory. This suggests selling pressure may be fading. Improving economic prospects within Europe, coupled with relatively low inflation risks, could attract renewed interest from global investors, especially given limited exposure to the region in current US portfolios.

The current environment may offer a favourable entry point for a shift towards European markets. If economic data continues to exceed expectations, the euro could see ongoing demand as confidence builds in the bloc’s recovery.

Looking ahead

Investors will now turn their attention to this week’s US retail sales and US producer price figures for fresh clues on the state of the US economy and the likely direction of monetary policy.

Attention in both the UK and eurozone is turning towards next week’s key diplomatic gathering, as leaders prepare for a UK-EU summit scheduled for the 19th of May. The European Council has outlined a wide-ranging agenda, covering defence cooperation, internal security, criminal justice, food safety standards, emissions trading, migration, and youth mobility. The scope of discussions suggests a shift towards a more comprehensive partnership between the two sides, potentially laying the groundwork for a refreshed framework of cooperation. Currency strategists note that such developments could offer meaningful support to the UK’s economic prospects and lend further strength to the Pound, particularly if the talks foster greater policy alignment and reduce post-Brexit friction.

Global financial markets are likely to stay sensitive to the evolving landscape of trade tariffs and geopolitical flashpoints. These factors have the potential to trigger renewed demand for safe-haven assets, influencing currency movements and steering foreign exchange trends in unpredictable directions.

Markets rally as US-China tariff rollback calms investors

Not long ago, a 30% tariff on Chinese goods seemed excessive. Today, it's part of a sweeping rollback that's helped trigger one of the strongest stock market surges since 2020. The S&P has soared in its best 22-day run since the pandemic, buoyed by renewed optimism as the US and China ease trade tensions.

The new deal slashes US tariffs on Chinese imports from 145% to 30%, while China cuts its own from 125% to 10%. China also plans to lift various non-tariff measures, though rare earths and tech sanctions were left unaddressed. The US will keep earlier tariffs on steel, intellectual property, and fentanyl, and low-value parcels under $800 from China remain subject to duties. Key sectors—like electric vehicles and aluminium—are still protected under existing tariffs.

Despite the upbeat markets, the US dollar remains 6% down year-to-date, even as it recovers from recent lows. Further gains will depend on stronger global demand. With a 90-day window for implementation and ongoing talks elsewhere—stalemates with Japan, no deal expected in South Korea, and looming EU retaliatory tariffs—uncertainty is far from over. For now, though, relief has returned to the markets.

Euro slips further as markets rotate back to US assets

The euro continues to weaken as easing trade tensions spark a reversal in the “sell America” narrative, lifting US equities and pushing oil prices higher. With volatility declining, the strong inverse link between the euro, US stocks, and crude prices is adding further pressure to the common currency, now nearly 5% below recent highs.

Oil's recent rally—driven by hopes that the global trade fallout may be less damaging than expected—is raising commodity prices. For Europe, a major oil importer, this spells higher energy costs, further dragging on the euro. On Monday, EUR/USD fell 1.4%, its sharpest daily drop since the post-election slump, dipping towards the $1.11 level. A break below $1.1084, the 50-day moving average, could open the door to $1.10 in the short term. Today’s ZEW surveys in Germany will be key in gauging near-term direction.

Attention may now turn to yield spreads. The Federal Reserve's cautious approach supports the dollar, especially against a backdrop of expected ECB rate cuts. However, any signs of US economic softening could reignite expectations for a dovish Fed pivot, tempering dollar strength and offering some relief to the euro.

Pound drops on Dollar strength, but Sterling outlook remains positive

The pound saw its biggest one-day drop in a month on Monday, slipping as the US dollar rallied on upbeat US-China trade news. GBP/USD is hovering near $1.32, down over two cents from its 2025 high, with a move toward $1.3091—the 50-day average—looking possible in the short term.

Despite the dip, GBP/EUR remains supported by easing UK recession risks, favourable yield spreads, and a trade boost from the recent US-UK deal. A break above €1.19 remains on the cards if risk appetite holds.

UK labour data showed unemployment rising to 4.5%, payrolls falling by 33,000, and wage growth slowing to 5.6%. While softer than expected, pay levels remain too high for the Bank of England to shift decisively towards rate cuts.