Pound storms to $1.31 amid rate expectations
Diverging interest rate expectations remain in the pound’s favour as the UK-US two-year bond yield spread climbs to its highest since 2014. After flirting with the key $1.30 handle, GBP/USD has catapulted through $1.31, a level it’s only been above for around 40% of the post-Brexit era. The currency pair’s latest uplift was helped by soft US inflation data as well as better-than-expected UK GDP data and strong wage growth this week.
UK macro data this week confirmed that wages continue to rise at the joint highest rate on record, whilst Britain’s economy shrank by less than expected in May. Meanwhile, the UK government has confirmed public sector workers will receive at least 6% pay increases following the worst period of industrial unrest in more than 30 years. These developments reinforce the notion the Bank of England (BoE) will likely continue raising interest rates to tackle inflation, potentially without derailing growth. We remain wary, however, of the longer-term economic drag from rate hikes and the looming housing crisis and credit risks that will weigh on the pound’s attractiveness further down the line. Still, market participants have been happy to overlook (for now) the most overbought conditions on GBP/USD since 2020, signalled by the daily Relative Strength Index at 76. It seems like a risky bet to chase higher at this stage, although because of the continued US dollar weakness expected, the currency pair has potential to climb towards $1.33 over the next few months.
Against the euro, sterling is still struggling to hold above €1.17, as both the euro and pound climb to over one-year highs against the dollar, which points to the latest FX price action being mainly driven by the weak US dollar story rather than sterling strength.
Dollar on track for worst week of the year
The US dollar index has slumped to a fresh 15-month low and back under the key 100 mark as softer-than-expected US producer and consumer price numbers this week supported speculations that the Federal Reserve (Fed) may be nearing the end of its rate-hiking cycle. The dollar index is heading for its biggest weekly slide so far this year and the gauge is now down over 12% from its September peak.
Earlier this week, we saw the annual consumer inflation rate in the US slowed to 3% in June, coming in below market expectations of 3.1%, while the core inflation rate eased below 5% and super core fell below 3% for the first time in two years. Importantly, the share of items rising at or below the key 2% level on a 3-month annualised rate rose to 54%, the highest share since November 2020. In addition, data on US producer inflation yesterday revealed prices went up 0.1% from a month earlier, less than forecasts of 0.2%, while core PPI, which strips out food, energy and trade services components, also edged up just 0.1%. Overall, the US inflation data this week has given rise to the dollar-negative narrative that the Fed is close to being done with hiking. Although the US central bank is still seen raising rates by 25 basis points this month, expectations of any further increases have evaporated. The dollar index has reversed almost 60% of the gains that followed the Fed’s taper signal in June 2021, and the drop has accelerated recently with every G10 currency strengthening against the USD over the past month.
Today we have US import prices and the University of Michigan consumer sentiment survey and its inflation expectations measure, which will be closely watched for further clues on whether disinflation will continue through the summer months.
US macro drives euro to 16-month high
The euro has staged an impressive turnaround versus the US dollar in the past two months against the backdrop of easing recession fears and the slowdown in inflation. A weaker than expected US CPI print on Wednesday ignited a global risk rally, which pushed equities to 15-month highs and reduced the markets expectations for the US central bank to continue tightening its monetary policy after the July meeting in two weeks time.
The relationship between the euro and 1. global equities and 2. future Fed pricing makes clear how little the appreciation of EUR/USD beyond $1.12 has been driven by European factors. It is true that the European Central Bank’s hawkish stance continues to be a backbone for its common currency. However, with economic activity faltering and inflation cooling in the 20-country block, the macro side of things has not been supportive for the euro. Still, the optimism surrounding the common currency based on US centric developments have pushed the consensus call on Wall Street for EUR/USD higher, with long positions continuing to outweigh the number of investors shorting the currency pair by a large margin.
Today will most likely mark a quite end to as busy week with no important macro data scheduled. The next week will once again be very US data driven with retail sales, industrial production and housing data coming up. The current bout of euro strength depends on the Fed not hiking beyond July, which means that the data must continue supporting that narrative for the euro to outperform.
Pound and euro up 3% vs US dollar
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: July 10-14
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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.
