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ECB decision beckons

Pound eying post-Brexit high, ECB in spotlight. Let’s talk about tariffs. Smaller BoC moves loom from here.

Written by Convera’s Market Insights team

Pound eying post-Brexit high, ECB in spotlight

George Vessey – Lead FX Strategist

The pound continues to inch further north of the €1.21 handle versus the euro. We’ve been calling for more upside for several weeks, helped by the fact the pair has formed a comfy support above €1.20 since the start of the month. The European Central Bank (ECB) is expected to cut rates by 25bps today, and the updated economic forecasts are likely to reflect the deterioration in the outlook, potentially weighing further on the common currency.

Since the Brexit vote in 2016, GBP/EUR has spent 85% of its time trading between €1.11 and €1.20. It’s spent less than 1% of its time above €1.21, which is beyond one standard deviation higher than the post-2016-referendum average. Will we see a continuation of this eight-year trading pattern and GBP/EUR mean revert from here? Or have we broken into a new higher trading range since the pair looks set to close the year above €1.20 for the first time since 2015? Positive momentum looks favourable for now. Relative political stability in the UK, with some mild fiscal stimulus vastly contrasts to the current impasse in continental Europe. Thus, the economic outlook looks more favourable for the UK too. This also supports the notion that the Bank of England’s (BoE) policy trajectory will be closer to the Fed than the ECB, providing the pound a bigger yield advantage over the euro.

As a result, a re-test of the 2022 high nearer €1.22 looks feasible, but as attractive as this might be for UK importers exposed to euros, hedging costs remain highly elevated as 1-year GBP/EUR rate differentials are -200bps. A more dovish BoE could combat this, but that would only drag the GBP/EUR spot price down as well.

Chart of GBPEUR post Brexit

Let’s talk about tariffs

Boris Kovacevic – Global Macro Strategist

The big elephant in the room going into 2025 is the upcoming intensification of the global trade war that is likely to be kicked off by the rollout of new tariffs by US President-elect Donald Trump. The US does not operate in a vacuum and trade volumes clear globally, not bilaterally. This was clearly highlighted by the first US-China trade war that started in 2017. While the Chinese share of US imports decreased over the following five years, the US’ dependence on the rest of the world did not. Trade volumes just shifted from China to regions like Vietnam, Mexico, Canada, and the Eurozone.

The extent to which tariffs will impact markets will depend on the 1) rollout timeframe, 2) size of the tariffs, 3) actual tariff scheme, and 4) retaliatory measures taken against the US by other countries. The good thing for now: Even the most bearish scenarios don’t envision a large impact of tariffs on growth or inflation next year. Most of the impact will likely be felt in 2026.

Coming back to development this week but staying at the topic of tariffs, one heading that moved markets yesterday came out of China. According to reports from Reuters, China is considering allowing the yuan to weaken in 2025 as a defence mechanism against higher tariffs under Trump 2.0. This led to a wave of weakness across EM FX and equities. The dollar benefited from the insider news headline and gives us a good template of what to expect next year. At the same time, US inflation increased from 2.6% to 2.7% as expected. Core inflation rose by 30 basis points on the month for a fourth consecutive month. While not ideal for the Fed, the consensus increase will not be enough to deter the central bank to cut rates by 25 basis points next week. However, it does look increasingly likely that January might be a pause for policy makers. The dollar gained for a fourth straight session with EUR/USD falling below $1.05 once again.

Chart of USDCNY

Smaller BoC moves loom from here

George Vessey – Lead FX Strategist

The Bank of Canada (BoC) cut its policy interest rate by 50bp for a second straight time. This was largely priced in though, and the surprisingly hawkish tone from Governor Tiff Macklem, saying future cuts will be more gradual, gave the Canadian dollar a welcome boost.

The BoC has already lowered rates (175bps) more than any other G10 central bank this year. But following the jumbo cut yesterday, Canadian interest rate expectations started rising and only 60 more basis points of cuts are being priced in for mid-way through 2025. The gap between US and Canada two-year yields fell, and USD/CAD pulled back from over 4-year highs. The pair remains around 7% higher year-to-date though, and is eying its best year since 2018.

Given Canadian inflation is already at target, the labour market is an tough spot and growth is disappointing, this will justify further rate cuts in the future by the BoC, but at a slower pace. What could be a more important driver of the CAD’s fortunes is if US President-elect Donald Trump’s goes ahead with his tariff threats on Canada. Even if they don’t come to fruition until 2026, risk aversion would likely feed negatively into cyclical currencies like the Loonie.

Chart of G10 central banks

Sterling pound in sea of green

Table: 7-day currency trends and trading ranges

Key global risk events

Calendar: December 9-13

Table of risk events

All times are in GMT

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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.

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