BoE cuts as expected
As we expected, the Bank of England delivered a 25bp rate cut today. But in a rare moment of monetary theatre, the initial vote split was a deadlock: 4 members voted to cut, 4 to hold, and 1 for a more aggressive 50bp cut. That forced a recast, with dovish outlier Alan Taylor switching his vote from 50bp to 25bp, tipping the final tally to 5-4 in favour of a cut.
But it’s the four votes to hold rates steady that caught markets off guard. The pound jumped higher on the news, in line with surging gilt yields, as traders recalibrated expectations for further easing. The odds of another cut in Q4 have now dropped to less than 65%, down from over 90% before the decision.
This shift reflects a more hawkish tone than we anticipated – especially given the backdrop of weak economic activity. Policymakers appear increasingly concerned about persistent inflation risks, particularly in services and food, even as growth indicators soften. It’s a classic stagflation setup: rising prices, slowing momentum, and limited policy flexibility.
While sterling initially rallied, gains may be capped. In fact, after each BoE decision during this cutting cycle, GBP/USD has, on average, fallen by 0.6%. That’s a clear pattern of post-announcement weakness – even when the pound pops higher in the immediate aftermath. This means sterling’s knee-jerk strength could be a fade opportunity, not a trend shift.
The hawkish cut signals caution, not confidence, and the Bank’s reluctance to commit to a faster easing path leaves the pound vulnerable to future data disappointments.
Two Kevins
While the full extent of the economic damage from the new tariff regime is yet to be seen, the pressure on the Fed to adopt a more dovish stance is unlikely to disappear. This pressure could intensify as President Trump has announced a decision on a new Fed governor will be made “before the end of the week.” He also stated that four people are being considered for the position of Fed chair, including “two Kevins and two other people.” Currently, Kevin Warsh, former FOMC governor from 2006 to 2011, appears to be the front-runner to replace Powell. The prospect of Powell’s successor being known in advance, effectively creating a “shadow Fed,” will likely weigh on market sentiment and the dollar.
Adding to the chorus of concern is Minneapolis Fed President Neel Kashkari, who stated in a CNBC interview that “the economy is slowing.” He suggested it may “become appropriate to start adjusting the federal funds rate,” referring to the central bank’s benchmark rate. Kashkari also highlighted the significant uncertainty surrounding tariffs and their impact on inflation, questioning, “How long can we wait until the tariff effects become clear? That’s just weighing on me right now.” He suggested that making “some adjustments and then we have to pause, or even then we have to reverse course, might be better than just sitting here on hold until we get clarity on tariffs.”
Meanwhile, the 10-year breakeven rate, a key measure of long-term inflation expectations for the Fed, has been steadily climbing since mid-April.
As real yields drop and the yield curve steepens, the dollar is feeling the weight of economic slowdown worries. As the market’s focus shifts from broad macro shocks to specific bilateral agreements, investor attention is increasingly turning toward macro indicators like inflation and growth. Emerging markets, led by China, could provide some of the earliest clues. The recent rally in U.S. assets alongside softening commodity prices underscores rising skepticism about global growth outside the U.S. The soft-landing narrative for the U.S. economy, however, remains a key anchor. If this narrative were to be shaken, it could trigger a rapid shift in market positioning. For now, it remains the primary source of the dollar’s vulnerability, and the market will likely remain cautious before allowing for renewed dollar strength.
Euro’s swift comeback
Last week’s warning that the euro’s slide against the dollar might be short-lived has already played out faster than we expected. EUR/USD posted its strongest daily gain since April following Friday’s soft US jobs report and has climbed another 0.7% this week, reclaiming ground above its 21-day moving average.
The correlation between EUR/USD and short-term yield spreads has surged back to 2025 highs, after fading earlier this year when the euro briefly acted as a haven amid US recession fears. With rate differentials once again steering the narrative, the pair looks poised to catch up, especially if the Fed leans as dovish as markets now anticipate.
Traders are pricing in up to 75bps of Fed cuts by year-end, spurred by weak US employment and services data. Treasury buying and rate-cut hedging have intensified. In contrast, the ECB remains cautious, with swaps showing less than a 50% chance of further easing. Some Governing Council members, including outgoing hawk Holzmann, are pushing back against additional cuts, citing inflation near target and reduced external risks following a new trade deal with the US.
Meanwhile, President Trump’s latest tariff threats have revived policy uncertainty and volatility, raising fears that US growth could take a bigger hit than elsewhere. That’s helping reinforce the view that the euro may offer a more stable alternative to the dollar – a theme gaining traction as rate dynamics shift in the euro’s favour.
Banxico to cut by 25 bps
After a period of quiet, Mexico’s financial markets have roared to life. Throughout 2025, a flood of capital has poured into the country, a trend fueled by a revived carry trade. This dynamic has driven the Mexican peso to an impressive appreciation against the U.S. dollar, while the Bolsa Mexicana de Valores (BMV) has delivered stunning returns. As of today, the IPC Index has gained a remarkable 15.4%, and the peso has strengthened by 12% year-to-date. The primary engine behind this rally has been a substantial interest rate spread. With the U.S. Federal Reserve holding its overnight rate at 4.5%, Banco de México (Banxico) has maintained a much higher rate, currently at 8%. This yawning gap has been a powerful incentive for investors to borrow cheaply in low-rate currencies and invest in high-yield Mexican assets, a classic carry trade strategy.
Against a backdrop of trade uncertainty, the Mexican economy has shown surprising resilience. According to the National Institute of Statistics and Geography (INEGI), Mexico’s GDP expanded by a seasonally adjusted 0.7% in the second quarter, handily beating market expectations of a 0.4% increase. This marks the sharpest pace of growth since late 2024. Growth was broadly based, with the services sector expanding by 0.7% and manufacturing growing by 0.8%, which offset a 1.3% plunge in primary industries. The economy’s year-over-year growth, however, was a more modest 0.1%. This latest data suggests that Banxico’s recent easing cycle, four consecutive rate cuts of 50 basis points each, is beginning to have its intended effect. The central bank is widely expected to continue this trend with another 25 basis point cut today.
While Banxico’s dovish pivot is helping the domestic economy, it also directly narrows the very interest rate spread that has made the peso so attractive to foreign capital. This could reduce the currency’s appeal to carry traders and temper future gains. Beyond monetary policy, the specter of trade uncertainty remains the most significant risk. With more than 80% of Mexico’s exports heading north, the economy is highly sensitive to its relationship with the U.S. Recent tariff threats from Washington have cast a long shadow, and any escalation could trigger a flight to safety. This could see capital pulled out of emerging markets like Mexico, putting significant downward pressure on the peso. In short, while Mexico has enjoyed a banner year, the foundation of its strength is about to be tested. The key question for investors is whether the prospect of continued strong returns can outweigh the dual risks of a shrinking carry trade and unpredictable trade policy. The outcome of today’s Banxico meeting and any further developments on the trade front will be critical in determining if the peso’s impressive run can continue.
Swiss franc under pressure, Mexican Peso recovers ahead of Banxico meeting
Table: Currency trends, trading ranges and technical indicators
Key global risk events
Calendar: August 4-8
All times are in ET
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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.ve 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.
