Parallel to GBP/USD reaching a new 1-year high above $1.30 last week, bullish bets on the British currency surged to a record high. Although sterling has experienced a slight correction, the heavy speculative positioning in GBP ahead of the Bank of England’s (BoE) rate decision next week leaves the currency vulnerable.

According to Commodity Futures Trading Commission data, non-commercial traders, including hedge funds and asset managers, increased their net long position on the pound to an all-time high last week. This positioning reflects optimism about the UK’s better-than-expected economic performance this year, relative political stability with a majority Labour government, and the currency's attractiveness to carry traders due to the BoE delaying interest rate cuts. The carry trades, based on the pound’s high yields compared to other currencies, may unwind as uncertain monetary policy and the upcoming US presidential election approach. FX volatility has been low, supporting carry trade strategies, but if investor anxiety about price swings grows, high-yielding currencies sensitive to risk sentiment, like GBP, could suffer. Indeed, with upcoming Fed and BoE meetings, the 2-week implied volatility gauge has risen to its highest in a month.

Additionally, money markets see a 40% chance of a BoE quarter-point interest rate cut in August, giving bullish GBP traders another reason to be cautious. A surprise rate cut from the BoE could sharply weaken sterling. The 200-week moving average at $1.2850 is the first key support level to watch.

The Pound Sterling has reversed its recent gains, and we anticipate further declines to 1.1807 against the Euro and 1.2850 against the USD in the coming days if equity markets continue to struggle. The key economic events this week are the Eurozone and UK PMI releases, while ongoing political developments in the US remain significant.

The Pound to Euro exchange rate peaked at 1.1928 last Wednesday and has been pressured since due to worsening global investor sentiment, largely driven by escalating fears of a China-U.S. trade war. The Pound remains vulnerable to risk, weakening as stock markets decline, as seen last week.

In the next five days, the performance of global stock markets could be a major factor in determining the behaviour of the Pound against its main counterparts. According to median forecasts from over 30 investment banks, further declines in the exchange rate are expected, bringing it closer to the targets for September 2024 and year-end, which are still below the current levels.

Looking at the economic calendar, the significant events for the Euro and Pound Sterling this week are the UK and Eurozone PMI releases on Wednesday. Updated consensus forecasts are available on our calendar. If Eurozone data exceeds expectations, the Euro could see further recovery. Similarly, if UK PMIs exceed expectations, the Pound could regain some recently lost ground. However, disappointing data could push the exchange rate toward the downside targets mentioned earlier, as weak data might prompt the Bank of England to cut interest rates on August 1.

In the US, the confirmation of the new Democratic Presidential Nominee is expected to impact all asset classes. Current Vice President Kamala Harris is favoured to replace Biden, but Gretchen Whitmer of Michigan and Gavin Newsom are also potential candidates. Following the assassination attempt, Trump continues to lead in the polls, but a new Democratic candidate could start reversing this trend.

Sterling has given up a portion of its weekly gains, particularly against the stronger US dollar, pushing GBP/USD below the significant $1.30 level. Compounding the issue was this morning’s disappointing UK retail sales data for June.

Retail sales volumes in the UK dropped by 1.2% in June, following a 2.9% increase in May. All sub-sectors weakened, with department stores, clothing, and footwear retailers experiencing the most significant declines. Although the GfK Consumer Confidence indicator for the UK rose to -13 in July from -14 in June, marking its fourth consecutive month of improvement to the highest level since September 2021, retailers cited election uncertainty, poor weather, and low footfall as reasons for the weaker sales. The British pound had been appreciating against its peers after the stubborn services inflation data earlier this week led to reduced expectations of a Bank of England (BoE) rate cut. However, with private sector wage growth slowing and consumer spending cooling, the BoE’s August meeting is uncertain. Markets have somewhat priced out an August rate cut, but if the BoE does decide to ease next month, it would likely have a very negative impact on the pound.

Sterling is also under pressure against the euro after approaching near two-year highs earlier in the week. The GBP/EUR pair's hold on the €1.19 level has weakened as it tests its 200-month moving average, a strong resistance level over the past eight years.

The US dollar fell to its weakest level in about four months as traders fully anticipate the Federal Reserve (Fed) will implement an interest rate cut in September. This decline was exacerbated by a significant rally in the Japanese yen, which impacted global currency markets following comments made by Donald Trump regarding foreign exchange (FX) rates.

The Republican presidential nominee, Mr. Trump, stated that the strength of the US dollar has been detrimental to the competitiveness of US exports. He also highlighted that the weakness of the Japanese yen and Chinese yuan provides a trading advantage to Japan and China. This caused a shockwave through FX markets, putting pressure on the dollar and driving the yen sharply higher. The USD/JPY pair dropped over 1%, reaching a new five-week low amid growing concerns about whether short positions on the yen are excessive, especially considering Japanese officials' readiness to intervene and the anticipated interest rate hike by the Bank of Japan at the end of July.

Ultimately, despite Trump's remarks, high tariffs, tax cuts, a weak dollar, and low inflation are an incompatible mix. We are hesitant to predict significant dollar weakness in the second half of this year due to Trump’s inflationary policies, which tend to support the dollar. Nonetheless, the dollar index is now below its 200-day moving average and testing four-month lows.