Risk aversion has been sweeping through financial markets so far this week due to the heightened tensions in the Middle East.

Equity markets worldwide are trading lower and perceived ‘safe haven’ currencies (e.g. USD) have outperformed most of their peers. The involvement of Iran in the conflict is a worrying development for markets, with investors rightly fearful that retaliation from Israel could disrupt global oil supplies - Iran is the seventh largest oil producer in the world. Israel’s PM Netanyahu has vowed to strike back, and we would expect another leg upwards in oil should these threats materialise, particularly should it target the country’s oil refineries.

The USD had already strengthened earlier this week following some hawkish comments from Fed chair Powell and yesterday’s US services data (ISM) has dramatically reduced concerns over an imminent slowdown in the US, which has further bolstered the dollar. Investors’ focus will now turn to this afternoon’s non-farm payroll figures (1.30pm) for further clues on the state of the US labour market and how this will interest rate expectations.

Sterling lost ground yesterday following some surprisingly dovish comments from Bank of England chief Andrew Bailey. Markets were caught off guard as, seemingly out of nowhere, Bailey said that the bank could be ‘a bit more activist’ on rate cuts should we see further good news on UK inflation. Although the UK data has not necessarily deteriorated to an extent that would warrant such a shift in policy stance from the BoE since their last meeting and inflation remains in line with their forecasts, the comments were enough for markets to increase their expectations of more aggressive rate cuts from the BoE, which weakened the Pound. However, cautious comments from BoE Chief Economist Huw Pill this morning have provided a little bit of support Sterling. He said that "Further cuts in the bank rate remain in prospect but it will be important to guard against the risk of cutting rates either too far or too fast".

As a result, the GBP/USD rate is trading around 2.5 cents lower than where it started the week and touched a 3-week low earlier. The GBP/EUR dropped over 1% yesterday to hit a 2-week low but has since recovered 0.5 cent. The EUR/USD has dropped around 1.5% this week and trades around a 3-week low.

anzhela-bets-6HBpGLk4DgI-unsplash

Risk aversion dominates markets this week. USD stronger. 

Sterling has pushed higher and the USD has weakened following their respective central bank interest rate meetings.

The Federal Reserve decided to cut interest rates by a jumbo 0.5% last night. Expectations over the past week had been for a smaller 0.25% cut, but this changed over the past couple of days with the market sensing a larger cut was on the cards. So, although the USD weakened, the moves weren’t quite as dramatic as they could have been as it was largely priced in. Inflation appears to be less of a worry for policymakers and instead concerns are increasingly turning towards the Fed’s second goal, maximum employment. Their forecasts support these feelings, with a higher unemployment rate now projected and less persistent inflationary pressures compared to their last set of forecasts.  

As expected, the Bank of England have just voted to keep interest rates on hold. However, there was only one dissenter voting for a 0.25% cut (8-0-1) versus expectations for two dissenters, which has helped support Sterling on the release. Policymakers clearly still have enough concerns over the lingering UK inflation that they’re prepared to move slowly with regards to cutting interests. Therefore, providing UK inflation continues to be stubborn and the labour market remains tight, this may provide some underlying support for Sterling over its major peers, who at this stage appear to be cutting more aggressively.

As a result, the GBP/USD rate has hit the highest levels since February 2022 having pushed up 1% today. The GBP/EUR is up around a quarter of a percent but towards the top end of where it has traded since the start of August. The EUR/USD is up a cent today and trading around a 3-week high.

Fed cut by 0.5%, BoE on hold 

Currency markets remain in a state of flux ahead this week’s Federal Reserve (Weds) and Bank of England (Thurs) interest rate meetings.  

Investors are bracing themselves for the first US Federal Reserve interest rate cut since 2020. The ongoing question is whether this will be a more conservative 0.25% cut or a larger 0.5% cut. Swings in recent market expectations have created a lot of volatility in the USD and we expect this to continue into and after Wednesday’s decision. Traders are currently pricing in around a 59% chance of the larger 0.5% cut and therefore it’s still very much in the air. Along with the rate cut, analysts will also be focusing on the bank’s projections for the future path of interest rates over the next few years. So, regardless of the size of the cut, the tone in the accompanying statement and their future projections could also play a large part in how the USD performs in the coming weeks.

As anticipated, the European Central Bank cut interest rates by 0.25% on Thursday. They also lowered their growth forecasts but at the same time adjusted their core inflation estimates higher. Importantly, they signalled that another rate cut in October was very unlikely, which helped to counter the weaker growth outlook and ultimately helped support the Euro. This was particular evident against the USD where it seems the paces of cuts in the Eurozone will be at a slower pace than across the Atlantic.

The Pound remains relatively buoyant moving into this week’s Bank of England meeting. Although last week’s UK growth data missed expectations, it hasn’t materially altered the view that the UK economy is performing much better than economists had expected at the start of the year. In particular, the labour market is proving particularly resilient and inflation remains around the BoE’s 2% target. Markets are therefore expecting the BoE to keep rates on hold this week, as it’s likely policymakers will want to continue monitoring the data for further clues on when to next act. Consequently, Pound traders will instead be paying very close attention to the voting pattern. A close vote, with a handful of dissenters in favour of an immediate cut, could trigger some downside in the pound.

As a result, the GBP/USD has recovered nearly 2-cents from last week’s low and now trades at a 10-day high. The GBP/EUR continues to trade within a relatively tight range but towards the upper end of the past week. The EUR/USD has risen around 1% from last week’s low and now trades around a 2-week high.

US flag

Markets brace themselves for US rate cut

Sterling has recovered some its recent losses following better than expected UK job and earnings figures.

The data showed the unemployment rate declined to 4.2% in the three months to June versus expectations for an increase to 4.5% (and a previous reading of 4.4%). Furthermore, the average earnings in the three months from April to June came in at 5.4% versus expectations of 4.6%. This has supported the Pound as it reduces expectations for how aggressive the Bank of England will be with future rate cuts.

There’s been a rebound in global stock markets after last week’s sharp selloff which has improved risk sentiment and encouraged investment back into the Pound. However, there is still underlying cautiousness in the market around the deepening crisis in the Middle East and how far things will escalate. This is keeping the USD more resilient against its peers and seemingly keeping a lid on the GBP/USD rate at the moment.

As a result,  the GBP/USD rate has recovered around 1.1% from last week’s low and currently trades at an 8-day high. The GBP/EUR rate is up by around 1.2% from last week’s low and also trades at an 8-day high. Further clues on how well the UK economy is doing will be provided by tomorrow’s UK inflation data, Thursday’s UK growth data and Friday’s UK retail sales figures. So, we might see further volatility in the Pound as the week progresses. We also have some key US data releases this week, including US inflation figures (Weds), US retail sales (Thurs) and US consumer sentiment (Fri).

Employment

Pound climbs as unemployment rate unexpectedly falls

Sterling has moved lower today and safe haven currencies have rallied as market risk sentiment sours.

Stock markets across Europe and Asia have slumped this morning amidst growing concerns around a US economy slowdown. This has largely been triggered by weaker-than-expected US jobs data out on Friday afternoon. The US nonfarm payrolls report for July came in at 114k versus expectations closer to 175K, but the bigger surprise surrounded a jump in the US unemployment to 4.3% versus expectations (and previous reading) of 4.1% This – combined with some more recent weaker US data – may indicate that the US economy is struggling to bear the consequences of sustained higher interest rates. This has ramped up market odds for heavier interest rate cuts from the Fed (including a potential 0.5% cut next month) and therefore weakened the USD.

Growing fears of a deepening conflict in the Middle East have further boosted the flight towards perceived safe-haven currencies (e.g. Japanese Yen and Swiss Franc). Iran has promised to retaliate heavily after the assassination of Hamas leader Ismail Haniyeh on Iranian soil. Over the weekend, Iran-backed Hezbollah confirmed they launched dozens of missiles on Israel and concerns are growing over how far Iran will go with their reprisals. 

As a result, the US dollar has been suffering from the repricing in interest rate expectations which has pushed the EUR/USD rate up nearly 2-cents from Friday’s low and to a 5mth high. This move out of the USD and into Euro – combined with Sterling’s sensitivity to risk aversion – has dragged the GBP/EUR lower by over 2-cents from Friday and it now trades at an 11-week low. The GBP/USD has been choppy but continues to trade towards the lower end of where it has been over the past month. 

We have a fairly quiet week in terms of data and traders will continue to monitor the fallout from last week’s US jobs data and see whether there’s been somewhat of an overreaction (i.e. could there be a countertrend move). They’ll also be closely watching for any development out of the Middle East. 

inflation

Sterling declines as market risk aversion increases

UK interest rates were cut today for the first time in four years, down to 5% (a cut of 0.25%).

The decision arrived on a knife edge, with four MPC members voting to keep rates on hold being overruled by five voting in favour of the cut.

Prior to the decision, the market expected the outcome to be very close, but expectations shifted slightly more towards a cut as the morning drew on. Therefore, Sterling had already lost some ground going into the event, so was relatively unphased upon the decision with any losses quickly stemmed. In the press conference that followed, Governor Bailey didn’t give too much away about further cuts and implied that they’ll be guided by the data.

As things stand, traders are pricing in around a 55% chance of another rate cut at their next rate-setting meeting in September (19th). So, it could be another close call, but there are two key inflation reports (CPI – 14th Aug and 18th Sept) ahead of that meeting which could change these odds depending on their outcomes.

As a result, Sterling has been relatively choppy today. The GBP/USD has touched a 4-week low earlier but has since clawed back 0.5 cents and it currently trades at a 3-week low. The GBP/EUR had fallen to the lower end of its 3-week range but has now pulled back around 40pips since the earlier falls. Traders will now move their focus over to tomorrow’s US nonfarm payroll figures to gain a clearer picture of how well the US economy is performing. 

Bank of England

BoE cut rates for first time in 4yrs

The pound was unmoved overnight as the results of the UK general election confirmed what markets had long been pricing in: a Labour landslide victory.

The margin of victory will end up being quite a lot less than both the polls and projections had anticipated. Currently, Labour has won 411 seats in the House of Commons versus 119 for the Conservatives with 6 seats to declare. Whilst this isn’t quite the 280 seat majority that some had braced for, this will do little to obstruct new Prime Minister Starmer’s ability to force policy changes through the House of Commons.

Sterling has been supported in the lead-up to the vote, as investors currently see a Labour government as the best-case scenario for the UK economy. In particular, expectations that they will favour closer UK-EU relations has seemingly increased business confidence. Starmer will now have to convince investors that he has a credible fiscal plan that will boost UK growth to ensure that he doesn’t trigger an adverse reaction in bond markets (as what happened after Liz Truss’s mini-budget). Any suggestion of larger tax hikes than those laid out in the party’s manifesto would, however, likely be greeted negatively by market participants.

As a result, the GBP/USD trades towards the higher end of the range we’ve seen this year and currently at a 3-week high. The GBP/EUR remains buoyant but barely moved from yesterday with the market trading around 1.18.

Today’s US non-farm payrolls report will be the next big event for markets, followed by Sunday’s second round French election. So far, markets have been reacting in a sanguine manner to the French election, as Marine Le Pen’s far-right party are seen falling short of an absolute majority. Should this be confirmed at the weekend, the euro could rally modestly, albeit this seems largely priced in. A surprise National Rally majority would almost certainly trigger some downside in the Euro.

Downing street

Sterling unmoved as Labour landslide confirmed

As expected, the Bank of England have just voted to keep interest rates on hold and the split in votes mirrored May’s decision with seven votes to keep on hold versus two to cut.

The accompanying statement said that the decision was ‘finely balanced’ for some (slightly dovish), but a line that previously said things were 'moving in right direction’ for a cut was removed (countering this). The BoE re-iterated that rates are ‘under review’, but the bank ‘needs to be sure that inflation will stay low’. Growth forecasts were also upgraded slightly from the last meeting with Q2 GDP seen growing 0.5% (from +0.2% in May).

Sterling has come off modestly since the decision, as the BoE have kept the door ajar to an August cut without firmly committing to one. Market odds for an August rate cut have now increased to around 45% (from 28%), with September up to 92% (from 80%). 

Yesterday’s UK inflation data also came in line with expectations (at BoE 2% y/y target) and showed that prices are continuing to move lower. Next month’s UK inflation data release could be key in determining whether the BoE cut rates in August, as another decent drop lower in prices would likely give them enough confidence to make their first cut since this inflation crisis began.

BoE 2

BoE keep rates on hold. Odds rise for Aug cut (45%)

Yesterday saw UK inflation figures fall in line with expectation, with year-on-year annual figures fall to the target 2%, and core inflation reduce to 3.5%. Whilst this is promising, it must be noted that key inflation metrics show services pricing inflation is still around 5.5%, and food prices about 25% higher than they were two years ago.  

At midday today the BoE interest rate decision is set to take place. With consensus that rates will remain unchanged (staying at 5.25%), traders will be more focusing on the accompanying statement and voting pattern of the policy committee.

If more than two policymakers vote in favour of a rate cut, then there's a chance of some initial Pound Sterling weakness against its peers. On the other hand, Sterling could stay within its recent range if the BoE refrains from making any notable changes to its policy statement and the vote split remains the same (i.e. with seven officials voting for a hold). 

As we go into the afternoon GBP/USD trades just over 1.27 on UK inflation as expected before interest rate decision.the market, having retreated from previous gains, and GBP/EUR still trading firm into the 1.18’s.

News

Risk aversion dominates markets this week. USD stronger.

Fed cut by 0.5%, BoE on hold

Markets brace themselves for US rate cut

Pound climbs as unemployment rate unexpectedly falls

Sterling declines as market risk aversion increases

BoE cut rates for first time in 4yrs

Sterling unmoved as Labour landslide confirmed

BoE keep rates on hold. Odds rise for Aug cut (45%)

UK inflation as expected as BoE interest rate decision awaits

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