Last week was fairly constructive for Sterling, particularly against the Euro, with GBP/EUR breaking above 1.18 and reaching its highest level of the year. Interestingly, much of this has been driven by weakness in the Euro rather than any significant improvement in the UK’s economic outlook. France’s ongoing political and fiscal difficulties have become a major concern for European markets, with investors increasingly questioning how the country intends to manage its borrowing and bring its public finances under control.
These concerns have also been reflected in EUR/USD, which has fallen considerably over recent weeks as the Dollar continues to strengthen. France’s financial position is particularly important because of the size of its economy within the Eurozone, and while the ECB has already raised interest rates in September, higher borrowing costs are only adding to the difficulties facing governments with large amounts of debt.
For Sterling, the recent move above 1.18 is welcome news, particularly for anyone needing to purchase Euros. However, I would be cautious about interpreting it as a sign that the Pound is necessarily in a stronger position domestically. We still have the UK Budget approaching on 28 October, and my view remains that uncertainty around government borrowing, taxation and spending could weigh on Sterling as we get closer to the announcement. For now, the problems in France are proving to be a greater concern for markets, but that could change as the Budget approaches.
Looking at the week ahead, Monday should be relatively quiet, with Columbus Day in the United States and Thanksgiving in Canada affecting market activity. US equity markets remain open, although the Treasury cash market will be closed. We do have speeches from central-bank officials throughout the day, but there is little in the way of major economic data that I would expect to drive significant currency movements.
Tuesday is also relatively light, with further central-bank commentary and some secondary economic releases. Given the recent interest-rate decisions from the Fed, ECB and Bank of England, policymakers’ comments will still be worth following, particularly if they offer any indication of how concerned they remain about inflation and whether further tightening is necessary.
Wednesday brings the first major release of the week with US CPI inflation data. Headline inflation is expected to rise to around 3.7% year-on-year, largely reflecting the impact of higher energy prices, while core inflation is expected to remain considerably lower at around 2.5%. This is an important distinction because the Fed will want to understand whether the renewed inflationary pressure is predominantly coming from energy or whether it is becoming more widespread across the economy.
I still think the argument for another immediate Fed hike is less convincing than some of the recent inflation headlines might suggest. We have already seen signs of the US labour market weakening, and while inflation remains above target, there is a risk that further tightening begins to do more damage to employment and economic activity. Markets are currently leaning towards the Fed holding rates in October, although a significantly hotter inflation reading could change those expectations and provide another boost to the Dollar.
Thursday is probably the most important day for Sterling, with the latest UK GDP figures alongside industrial production and other economic releases. Following July’s stronger-than-expected 0.4% growth, expectations are for the economy to have been broadly flat in August. A weaker reading would not be particularly encouraging as we approach the Budget, especially given the concerns already surrounding the public finances and the possibility that interest rates may need to remain elevated for longer.
Later on Thursday we also have US Producer Price Index data, retail sales and weekly jobless claims. The combination should give us a better indication of whether inflation is continuing to build and how well the US consumer and labour market are holding up. I think the retail sales and employment figures are particularly important because the Fed is now trying to balance the need to control inflation against the possibility of slowing economic growth.
Friday brings the final Eurozone inflation figures, alongside trade-balance data and further central-bank speeches, including comments from Bank of England Governor Andrew Bailey and Fed Chair Kevin Warsh. Unless the inflation figures are revised materially, I wouldn’t expect the final reading to change the ECB outlook significantly, although any comments on future interest rates could still influence the Euro.
Overall, I think this week will be more important for the Dollar than Sterling, particularly with Wednesday’s inflation figures and Thursday’s US releases. For the Pound, the recent improvement against the Euro has been encouraging, but I am still conscious that we are approaching a potentially difficult period domestically.
My view on the Budget hasn’t changed. I think Sterling could come under some pressure as we approach 28 October, particularly if we see further speculation around tax increases and government borrowing.
However, I still believe there is a reasonable chance that the Budget itself proves less disruptive than the build-up, provided the Government delivers something credible and avoids any major surprises.
In the meantime, GBP/EUR above 1.18 is a significant improvement for Euro buyers, although the reasons behind the move are worth keeping in mind. France’s difficulties have helped Sterling considerably, but with both the UK Budget and another Fed decision approaching later this month, I wouldn’t assume that the recent direction of these currency pairs will continue uninterrupted.