Dollar stronger, but key level remains elusive

Dollar stronger, but key level remains elusive

Foreign exchange markets appear considerably more sensitive to escalating tariff risks than equity investors, who seem relatively complacent about the threats issued by President Trump. While the S&P 500 has remained range-bound since mid-November, it is still up by 6% since the US election, driven by an initial post-election rally. Meanwhile, European equities have slightly outperformed, rising nearly 8% over the same period.

This resilience in global stock markets is particularly notable, given the intensifying trade rhetoric and the significant reduction in expectations for Federal Reserve easing over recent months. However, key upcoming events—Wednesday’s inflation report, Federal Reserve Chair Jerome Powell’s congressional testimony on Tuesday, and further trade developments—could provide the momentum needed for equities to break out of their recent consolidation. The US dollar has strengthened for a third consecutive session, but gains remain limited, with the 3% trading range since mid-December still intact.

As we have previously argued, further upside for the dollar depends on sustained trade escalation and the actual implementation of tariffs. With the Federal Reserve pause fully priced in, the dollar now requires either a stronger US macroeconomic backdrop or deteriorating risk sentiment to make meaningful gains. At present, the high noise-to-signal ratio makes shorting the Greenback a difficult case to justify.

Struggling to hold above $1.0350

EUR/USD extended its losing streak to a third consecutive session, weighed down by dollar strength and ongoing trade concerns. However, the downside has remained limited as European equities continue their impressive performance, with the STOXX 600 closing at a fresh record high, reflecting investor confidence in the region’s economic resilience. Stronger bond yields have also provided some support, as markets reassess the European Central Bank’s (ECB) policy path amid shifting inflation dynamics.

The latest Sentix investor sentiment index showed a marked improvement in eurozone morale, rising to its highest level since July, suggesting that optimism is gradually returning to the region despite persistent economic headwinds. ECB President Christine Lagarde maintained the central bank’s outlook, reiterating that inflation remains on track to return to the 2% target this year. However, she cautioned that rising trade tensions, particularly those stemming from the United States, could pose risks to the outlook, making the ECB’s policy path more uncertain in the months ahead.

Meanwhile, German Chancellor Olaf Scholz issued a stark warning, stating that the European Union is closely monitoring the situation and will not hesitate to retaliate if the US proceeds with tariffs on EU exports. His comments underscored growing concerns that transatlantic trade relations could deteriorate further, injecting another layer of uncertainty into the euro’s outlook. While the currency has managed to hold above key technical levels for now, escalating trade risks and diverging central bank policies could keep EUR/USD under pressure in the near term.

Will the pound outperform the euro again this year?

GBP/EUR is over 1% lower year-to-date but has recently rebounded from five-month lows, thanks to a slightly more optimistic UK domestic backdrop. More significantly, tariff risks are perceived as more damaging to the Eurozone economy than to the UK. The currency pair is encountering resistance around its 50-day moving average at €1.20 but remains above its 200-day moving average, which is trending higher—a sign of sustained upward momentum.

The currency pair continues to avoid substantial daily fluctuations. In fact, GBP/EUR has not recorded a daily rise or fall of 1% or more for over 500 trading days. Though lacking volatility, GBP/EUR experienced a healthy uptrend in 2024, finishing the year nearly 5% higher and recording its highest year-end close since 2016. Two key contributors to this uptrend have been heightened European political risks and elevated UK-German short-term yield spreads, although both have recently stabilised at lower levels. These macroeconomic drivers suggest that GBP/EUR should be trading closer to €1.18-€1.19. Thus, we believe sterling is benefiting from its lower sensitivity to tariff risks compared to the euro. Should tariff threats against the EU materialise, we would not rule out GBP/EUR extending above €1.21—a level it has only surpassed for 1% of the time since Britain voted to leave the EU in 2016.

From a macroeconomic perspective, the Eurozone economy stagnated at the end of 2024, and recent high-frequency indicators suggest that economic activity is likely to remain subdued in the near term. In the UK, economic activity has also weakened, although recent survey data points to a moderate revival. This week’s UK real GDP data is expected to show no economic growth in the fourth quarter of 2024.

In terms of monetary policy, markets are pricing in 66 basis points of Bank of England easing by year-end, compared to 90 basis points for the ECB. The two primary risks to further GBP/EUR upside are increased expectations of BoE rate cuts and a softening of the tariff narrative. The former is already materialising to some extent, with the BoE’s Catherine Mann—previously considered one of the committee’s more hawkish voices—adopting a more cautious tone and expressing concerns about slowing consumption and the labour market.

 

Persistence tariff risks

Sterling Holds Steady Amid Trade Tensions and BoE Signals

Market focus remains on trade tensions, yet the British pound continues to show resilience due to its limited direct exposure to US tariffs. While uncertainty around global trade impacts sterling against traditional safe-haven currencies, it has largely supported other sterling pairs. Meanwhile, the Bank of England’s (BoE) divided vote on interest rates was balanced by an upward revision to inflation forecasts. This week, UK GDP data will be a key factor in determining sterling’s next move.

At the start of last week, sterling experienced heightened volatility due to shifts in global risk sentiment but outperformed other risk-sensitive G10 currencies. Investors appear to view the UK as less vulnerable to direct tariff threats from the US. GBP/EUR extended its gains, climbing past €1.20—four cents above its five-year average. Midweek, focus shifted to monetary policy when BoE policymaker Catherine Mann unexpectedly joined Swati Dhingra in advocating for faster rate cuts, pushing GBP/USD down toward $1.23. The BoE also downgraded its 2025 growth forecast to 0.75% from 1.5%, but a rise in near-term inflation expectations helped support sterling by driving UK gilt yields higher.

Despite a broader downtrend indicated by long-term moving averages, a recent breakout above a descending trendline suggests potential upside. A sustained move above $1.24 could open the door for gains toward $1.26.

US Jobs Report Sends Mixed Signals as Inflation Concerns Persist

January’s US employment data presented a mixed picture for investors. Job growth slowed, but wages rose, reinforcing ongoing inflation concerns fuelled by trade tensions and rising price expectations. This uncertainty helped lift the dollar ahead of the weekend, though not enough to reverse its weekly decline.

Nonfarm payrolls increased by 143k, missing the 175k consensus estimate. However, revisions to the previous two months added 100k jobs, and the unemployment rate remained at 4.0%, beating expectations of a slight uptick to 4.1%. Wage growth remained strong, with average hourly earnings rising 0.5% month-over-month, though the average workweek dropped to 34.1 hours—its lowest level since the pandemic. These dynamics suggest the Federal Reserve may maintain its current policy stance, with options markets now pricing in just two rate cuts for the easing cycle.

Euro Struggles Against Dollar as Trade Tensions Weigh on Sentiment

The euro came under pressure against the US dollar on Friday, though losses were not enough to erase gains from earlier in the week. However, the swift pullback after reaching the 50-day moving average at $1.0410 signalled investor concerns about the Eurozone’s economic outlook amid escalating trade tensions.

The dollar’s strength was further reinforced by its safe-haven appeal during times of global uncertainty. Last week’s market action highlighted both the vulnerability of global markets to shifting policies and the ability of equities to rise as long as corporate earnings continue to exceed expectations.

This week

Looking ahead, markets face a busy economic calendar this week, with key inflation data, industrial production figures, and retail sales reports set to drive sentiment. The Consumer Price Index (CPI) and Producer Price Index (PPI) will be closely watched, given renewed concerns over inflationary pressures. A stronger-than-expected reading could reinforce fears of persistent inflation, potentially influencing the Fed’s rate-cut trajectory. Key data releases this week include UK growth and industrial production figures on Thursday, while US inflation data on Wednesday will also influence GBP/USD movements.

Investor focus will turn to key survey data to assess whether the European economy has found a floor. The ZEW surveys for Germany and the broader Eurozone, along with the EU’s flash consumer confidence reports, will take centre stage. The week will wrap up with the Flash Purchasing Managers’ Index (PMI) on Friday, a crucial forward-looking indicator. For EUR/USD to hold above $1.03 and establish a bottom, the euro will need support from stronger domestic data, especially as trade tensions continue to escalate.

 

Inflationary pressures continue to grow

BoE Rate Cut Sparks Pound Volatility Amid Inflation Concerns

The Bank of England (BoE) cut its benchmark interest rate by 25 basis points to 4.5% in a 7-2 vote, a widely expected move. However, the unexpected vote split triggered a brief selloff in the pound. GBP/USD dropped towards $1.23 from $1.25, while GBP/EUR slipped below €1.20. Selling pressure eased after Governor Andrew Bailey provided reassuring comments, and upward inflation revisions cast doubt on the likelihood of further aggressive rate cuts.

The decision highlighted divisions within the Monetary Policy Committee (MPC) and underscored deep uncertainty about the UK’s economic outlook. Dissenters Swati Dhingra and Catherine Mann pushed for a larger 50bp cut, with Mann’s shift particularly notable given her previously hawkish stance. This marked a clear dovish signal. However, the BoE’s inflation forecast revisions provided a more hawkish counterbalance. Additionally, the Bank sharply downgraded its GDP growth projection for 2025 from 1.5% to 0.7%, citing weaker-than-expected economic performance and a more subdued outlook for the first half of the year.

The UK’s persistent supply-side weaknesses continue to complicate the balance between growth and inflation. Low potential growth, sticky wage increases, and lingering inflationary pressures suggest that a prolonged period of sluggish GDP growth may be necessary to bring inflation sustainably back to target.

Looking ahead, next week’s inflation and GDP data will be pivotal in shaping expectations for the BoE’s next move. While the pound’s yield advantage is eroding, its limited exposure to tariff risks should help prevent significant weakness against major currencies.

French Government Survives No-Confidence Vote, Markets React Positively

The French government successfully withstood a no-confidence vote on Wednesday, clearing the way for the long-delayed annual budget to move forward. While widely expected, this outcome remains a constructive development for markets. The French risk premium—measured by the yield spread between French and German bonds—has eased from its peak of 90 basis points to 70. Meanwhile, French equities have outperformed both U.S. and broader European markets, delivering a 7% gain year-to-date.

Additional support for risk assets could come from the European Central Bank, which is expected to lower rates by 87 basis points this year. However, the extent of policy easing will depend on U.S. tariff decisions and the pace of European inflation. Investors have tempered their expectations for rate cuts following remarks from ECB Chief Economist Philip Lane, who warned that inflation may take longer to subside than previously projected.

In the currency markets, the euro has extended its rally for a third straight session—its longest winning streak since late October. EUR/USD must break above the 50-day moving average at $1.0420 to maintain upward momentum toward $1.05.

BoE Cuts Rate

British Pound Slumps After BoE Rate Cut, but Recovery Likely

The British Pound weakened after the Bank of England (BoE) cut interest rates and downgraded the UK’s economic growth outlook. However, a rebound is expected in the coming days.

Markets interpreted the decision as dovish, reinforcing expectations of further rate cuts. Yet, the BoE also raised its inflation forecasts and stated that a "gradual and careful approach" to easing policy remains appropriate. This limits the scope for an aggressive rate-cutting cycle beyond the anticipated three cuts in 2025, making the initial Pound selloff appear overdone.

Much of the day's GBP weakness occurred before the announcement, likely due to tactical market positioning. However, further declines followed reports that two members of the nine-person Monetary Policy Committee (MPC) voted for a larger 50 basis point cut, signalling a push for a faster easing cycle.

A key surprise was Catherine Mann, a previously hawkish MPC member, switching her stance. Meeting minutes reveal she sought to send a "clear signal" on rates while acknowledging the need to keep policy restrictive. Her shift was likely driven by a sharp downgrade to UK growth forecasts, with GDP expected to rise just 0.4% year-on-year by Q1 2025, down from 1.4% projected in November 2024. The unemployment rate is also set to rise slightly to 4.75%.

However, rising inflation complicates the case for aggressive cuts. The latest Monetary Policy Report revised CPI inflation projections higher, with a peak of 3.7% in Q3 2025—up from the 2.8% previously forecast. Given the BoE's mandate to return inflation to 2.0%, this raises questions about the logic behind calls for faster rate cuts.

The UK economy now faces an increasingly stagflationary backdrop, where weak growth coincides with rising inflation. While the Pound should recover from its initial drop, a dominant stagflation narrative in the coming weeks could pose further downside risks.

Bank of England Signals Rate Cuts

Pound’s Recovery at Risk as Bank of England Signals Rate Cuts

The British Pound’s recent rebound against the Euro, Dollar, and other major currencies faces potential pressure today as the Bank of England prepares to lower interest rates and signal a continued easing cycle.

Markets anticipate a 25-basis-point cut to the Bank Rate, with expectations of two additional cuts in 2025. However, policymakers are likely to commit to at least three further cuts to maintain a steady quarterly pace. A shift in market expectations toward deeper rate reductions would put downward pressure on UK bond yields and Sterling, limiting its recent recovery. Currently, GBP/EUR stands at 1.2020, up from a mid-January low of 1.18, while GBP/USD has risen from 1.2099 on January 13 to 1.2485.

A majority of the Monetary Policy Committee (MPC) is expected to vote in favour of the rate cut, with Catherine Mann likely to dissent and support keeping rates at 4.75%. The decision follows December’s UK inflation data, which showed CPI rising 2.5% year-over-year, down from 2.6% in November and below the 2.7% forecast.

Alongside the rate cut, the Bank of England will release new economic projections, highlighting weaker growth and higher unemployment forecasts—reinforcing its case for continued monetary easing.

French Government Survives No-Confidence Vote, Markets React Positively

The French government successfully withstood a no-confidence vote on Wednesday, clearing the way for the long-delayed annual budget to move forward. While widely expected, this outcome remains a constructive development for markets. The French risk premium—measured by the yield spread between French and German bonds—has eased from its peak of 90 basis points to 70. Meanwhile, French equities have outperformed both U.S. and broader European markets, delivering a 7% gain year-to-date.

Additional support for risk assets could come from the European Central Bank, which is expected to lower rates by 87 basis points this year. However, the extent of policy easing will depend on U.S. tariff decisions and the pace of European inflation. Investors have tempered their expectations for rate cuts following remarks from ECB Chief Economist Philip Lane, who warned that inflation may take longer to subside than previously projected.

In the currency markets, the euro has extended its rally for a third straight session—its longest winning streak since late October. EUR/USD must break above the 50-day moving average at $1.0420 to maintain upward momentum toward $1.05.

Bond Yields Climb, Safe-Haven Demand Rises, and Dollar Weakens

Rising concerns over the U.S. budget deficit and increasing debt levels have contributed to a higher term premium, driving bond yields upward. However, investor sentiment improved after the Treasury confirmed it would maintain the size of its upcoming bond issuances, providing some stability to the market.

Meanwhile, demand for safe-haven assets spiked following a softer-than-expected ISM services report, which fell from 54 to 52.8. Despite this slowdown, the employment sub-index showed its strongest increase since September 2023, aligning with the robust ADP private payrolls report earlier in the day. This reinforces optimism ahead of Friday’s nonfarm payrolls release.

On the currency front, the U.S. dollar continued to slide as trade-related risk premiums eased. After depreciating against all G10 currencies in the previous session, market focus now shifts to the Bank of England’s policy decision, multiple Federal Reserve speeches, and the latest jobless claims report.

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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