The British Pound (GBP) strengthened against the EUR, USD, and other major currencies following reports of robust growth in the UK economy in January. According to the S&P Global PMI survey, the dominant services sector expanded with a reading of 53.8, surpassing December's 53.4 and exceeding the expected 53.2.

Although the manufacturing PMI remained at 47.3, indicating contraction, it was an improvement from December's 46.2 and above the consensus expectation of 46.7. The composite PMI, offering a more comprehensive view of the economy, registered at 52.5, up from December's 52.1 and surpassing the consensus of 52.2. The Pound to Euro exchange rate reached its highest level in four months at 1.1715, propelled by these better-than-expected figures. Eurozone PMI readings, falling short of expectations and indicative of economic contraction, further supported the Pound's strength. GBP/EUR exchange rate was quoted at 1.2755, a half-percent increase.

The data suggests that the UK economy is solidly in expansionary territory, potentially reducing the need for the Bank of England to implement interest rate cuts. The likelihood of higher UK rates for an extended period supports UK yields and boosts demand for the Pound. S&P Global noted that service sector activity saw its fastest rise since May, despite a decrease in manufacturing production, attributed to the disruptions in the Red Sea. The survey cautions against a premature policy shift by the Bank of England, especially considering reports of increased freight costs.

Concerningly, the survey reveals that private sector firms experienced the sharpest rise in input costs since August 2023. This, coupled with improving demand conditions and higher optimism toward the business outlook, is expected to keep domestic inflationary pressures robust. Resilient demand is anticipated to bolster employment, wages, and inflation. January data indicates a modest increase in private sector employment, ending a four-month period of job shedding. The rise in staffing levels is linked to a rebound in service sector recruitment driven by new project starts and anticipated demand growth. UK businesses exhibit a more positive outlook for growth in the next 12 months, with confidence levels at their highest since May 2023.

On Wednesday, the Bank of Canada (BoC) will be in the spotlight as one of the initial G10 central banks to announce its rate decision this year. The general expectation is that the central bank will maintain the overnight rate target at 5% during this week's meeting, given indications of reflation in the recent Consumer Price Index (CPI) data.

Following the last central bank policy rate meeting, Canada's headline CPI rate accelerated to 3.4% year-on-year in December 2023, up from 3.1% in the preceding month. The increase in consumer prices was primarily attributed to a rebound in gasoline costs due to diminishing base effects. Inflation also rose for shelter, as elevated mortgage rates discouraged home ownership and pushed up rental prices. This aligns with the BoC's indication that headline inflation is anticipated to persist at a stubbornly elevated level, hovering close to the 3.5% mark through the middle of the year.

The rise in domestic CPI led to an increase in Canadian government benchmark bond yields across the yield curve. Specifically, the yield on the 10-year government bond reached a six-week high at 3.48%, driven by increasingly hawkish signals from BoC members. While policymakers express a readiness to "further raise the policy rate if necessary," we foresee limited prospects for additional policy tightening from this point onward. Tomorrow's rates decision is expected to be uneventful, with the BoC leaning towards a hawkish stance. We will closely monitor any additional guidance on the projected timeline for rate adjustments, which we believe are unlikely to occur before Q2.

Meanwhile, market expectations have shifted, with a 50.2% probability of a rate cut in the April meeting, a significant drop from around 80% just a week ago. Investors are reassessing the likelihood of an imminent BoC policy rate shift, providing temporary support for the Canadian dollar. Currently, the Canadian dollar is the best-performing major G-10 currency since last Friday, albeit with modest gains amid the prevailing strength of the US dollar. Looking ahead, we anticipate that the bullish momentum in USD/CAD, observed since December 27th, is losing steam, and we project a depreciation of the pair from its current levels. Any hawkish pushback from the BoC tomorrow could bolster the Canadian dollar and contribute to a retracement of the USD/CAD pair towards the $1.34 handle.

In the United Kingdom, the prevailing news coverage centered on political developments against a backdrop of unclear macro drivers. On Monday, the US and UK jointly conducted new airstrikes against Houthi targets in Yemen. Concurrently, a decision by lawmakers in the House of Lords to postpone the contentious proposal of relocating migrants to Rwanda resulted in a divisive split within the conservative party. Despite these political dynamics, the impact on the pound was limited. As the morning unfolded, a slight indication of risk-on sentiment emerged, influenced by China's announcement of new stimulus measures on the policy front. Against this backdrop, GBP/USD continued its upward trend.

The currency pair has maintained a steady position around the $1.27 level for six consecutive weeks, showing no immediate catalyst to break out of its remarkably narrow range between $1.2600 and $1.2820. Tomorrow's release of the UK purchasing manager index holds the potential to drive FX price action. Analysts anticipate a marginal increase in the composite index from 52.1 to 52.2 in January, marking the third consecutive positive reading, fueled by a robust services sector. Looking ahead, aside from Friday's GfK consumer confidence figure, investor focus will shift to events in the Eurozone and the United States, which are expected to dominate the narrative for the remainder of the week.

Last week saw a mix of data in the UK, as headline inflation unexpectedly rose to 4.0%, while average earnings growth slowed to 6.5%. Inflationary pressures have significantly eased, and a resumption of the downward trend is anticipated in the coming months. Despite economic headwinds, the job market remains relatively robust, with unemployment holding steady at 4.2%.

Expectations for rate cuts in the UK have been scaled back by the markets, with approximately 1% of cuts currently projected by the year-end.

In Europe, headline inflation met expectations at 2.9%, and markets are factoring in potential rate cuts of up to 1.40%, given the persistently weak underlying economic fundamentals.

In the US, forecasters are still pricing in up to 1.50% of rate cuts for the year, possibly beginning in March, as the Federal Reserve shifts its focus from inflation to growth.

While the outlook for interest rate differentials continues to influence market sentiment, central bank policymakers are pushing back against the market's aggressive pricing for rate cuts, citing unprecedented uncertainty. This resistance is impacting global equity markets and pushing yields higher.

Geopolitical concerns remain at the forefront of investors' minds due to the escalating tensions. Disappointing Chinese growth data is weighing particularly on the European economy, and authorities are likely to implement additional economic stimulus.

Looking ahead to next week, there is little in terms of data, and no changes are expected at the European Central Bank meeting. Consequently, political events are likely to be the driving force behind market momentum.