The market experienced a relatively calm week, absorbing the recent central bank meetings and their implications for monetary policy. Authorities are cautious about early rate cuts, expressing concerns about cutting too soon. Economists are gradually adjusting their expectations in response.

The Bank of England is expected to cut rates by 0.85% around mid-year, but concerns about upside risks to inflation and persistently high pay settlements are prominent. The upcoming budget and the pressure for tax cuts contribute to the challenging macroeconomic environment.

In the US, the exceptionally strong payrolls report underscored the resilience of the underlying economy, making a March rate cut unlikely. Forecasters still anticipate an aggressive rate-cutting cycle of around 1.35% this year, potentially starting in May.

Europe might become the first major central bank to cut rates, possibly in April, given the challenging economic fundamentals within the bloc. Substantial drops in inflation and a gloomy growth outlook, especially in Germany, continue to pose challenges.

Geopolitical tensions persist with no clear resolution in sight, influencing market sentiment. China's ongoing economic weakness remains a drag on global growth, prompting authorities to consider additional stimulus.

On the exchanges, the strength of the dollar is shaping market dynamics, driven by the outperforming US economy, resulting in the recent lows for sterling and the euro. The upcoming week's extensive data releases are likely to contribute to increased market volatility.

The US dollar index rebounded yesterday, ending a two-day decline, fuelled by positive economic indicators from the US. Notably, it made significant gains against the Japanese yen, reaching 10-week highs as yield differentials widened. Concurrently, global equities, including the Nasdaq 100 and the S&P500, surged to new record highs. Today's focal point is the US Consumer Price Index (CPI) benchmark revisions, potentially introducing volatility ahead of the Lunar New Year holiday.

The continual influx of favourable economic data in the US reinforces the Federal Reserve's stance that interest rates will remain stable in the near future. A notable drop in new claims for unemployment benefits yesterday underscored the resilience of the US labour market, despite recent layoffs. Wage growth outpacing inflation is sustaining robust consumer spending. However, growth momentum is moderating, creating a disparity between strong official data and tepid business surveys. The Conference Board's leading index remains at levels historically associated with a recession.

USD strengthened against GBP, testing its 200-day moving average due to renewed demand for USD. Although the currency pair bounced off this critical level, it registered a daily decline, staying over 1% below its year-to-date high. GBP also faced losses against the EUR but held onto €1.17, while GBP/JPY advanced to 2-week highs.

Recent UK labour market data revealed an unemployment rate of 3.9% in the three months through November, lower than the previously estimated 4.2%. This tighter labour market may exert upward pressure on wages and prices, potentially influencing the Bank of England (BoE) to delay interest rate cuts. BoE policymaker Catherine Mann expressed concerns about the near-term deceleration in headline inflation, hinting at a close vote on raising interest rates last week. Flash UK inflation figures, alongside the jobs report and retail sales next week, could impact GBP.  In the short term, the outlook for GBP appears less favourable due to seasonality and positioning. A retreat towards $1.25 cannot be ruled out next week, especially if UK inflation continues to decline, juxtaposed with the resilient US economy.

EUR held steady at $1.0770 against the US dollar, with no significant market-moving events on the calendar once again. This lack of notable developments defined the entire week.  In the recent days, market expectations for ECB easing have notably receded, with the implied probability of an April rate cut hovering just slightly above a coin toss, at 51%.

GBP continues to stand strong, supported by data indicating a 2.5% increase in British house prices in the year leading up to January, marking the most robust annual growth rate in a year. This signals potential signs of a revitalised momentum in the housing market, reinforcing the recent assertive stance from the Bank of England (BoE).

Deputy Governor Sarah Breeden of the Bank of England (BoE) has indicated a lack of interest in implementing interest rate cuts. Instead, the focus is on determining the duration of maintaining current levels, rather than contemplating rate hikes. While this perspective aligns with that of numerous BoE policymakers, some, particularly the most dovish ones, have cautioned about an imminent economic downturn with rates reaching 16-year highs. The recent vote split at the BoE's meeting reflects this divergence, with two members advocating for a hike and one favouring a cut. Our alignment with the current market consensus suggests that cuts are likely to occur from summer onward, following the Federal Reserve's shift. We anticipate GBP/USD to approach $1.30 by the end of the year, driven by yield differentials favouring the pound. Nevertheless, persistent risks of UK stagflation pose a challenge.

In the short term, factors such as seasonality and positioning appear less favourable for GBP. Despite the positive rebound against the USD and other currency counterparts this week, a retreat towards GBP/USD 1.25 cannot be ruled out.

Once again, the calendar for today appears relatively subdued, devoid of significant data releases from both sides of the Atlantic. Although multiple speakers from the European Central Bank (ECB) are slated to address audiences throughout the day, any potential impact on the current ECB rhetoric is expected to be minimal. On the U.S. front, there may be a degree of interest in the jobless claims report, particularly given Federal Reserve Chair Powell's emphasis on the significance of U.S. labour market reports in the recent Federal Open Market Committee (FOMC) meeting.

February has been challenging so far for GBP, as it has appreciated against less than 40% of its global counterparts, a notable contrast to the over 70% increase observed in January. Despite this, a modest rebound in GBP demand on Tuesday allowed GBP/EUR to reclaim 1.17 and GBP/USD 1.26.

Rate differentials remain relatively unchanged, with the Bank of England (BoE) not anticipated to cut interest rates as extensively as the ECB or Fed in the coming year. However, there is a growing disparity in economic surprises, reflecting the variance between consensus expectations and actual data.  Over the past month, the UK has experienced more disappointing economic surprises compared to the US and Eurozone, potentially contributing to the recent weakness in GBP.  Elevated concerns about stagflation in the UK, particularly due to persistent services inflation, further contribute to this trend, albeit lagging behind the declines observed in the US and Eurozone.  Some argue that this situation supports the idea of higher BoE rates for a more extended period, offering GBP a yield advantage, as witnessed in January.

Nevertheless, the most dovish member of the BoE's interest-rate-setting committee, who advocated for a rate cut last week, warned that the current weakness in the UK economy poses a risk of a significant shock if restrictive interest rates are maintained. The upcoming UK inflation report, scheduled for next week, could play a crucial role in shaping market sentiment. If the report indicates a resumption of the descent in inflation after the surprise uptick in December, it may lead to a dovish repricing in UK rates, exerting additional downward pressure on the pound.

While the UK's data docket is relatively thin this week, recent retail sales data from the British Retail Consortium revealed a 1.4% increase on a like-for-like basis in January 2024 compared to a year ago, marking the second consecutive month of slowing growth.