Euro Gains Momentum Amid Global Optimism
The euro is making steady gains, buoyed by a shift towards risk appetite in financial markets. Stock indices across major economies are on the rise, driven by stronger-than-expected economic data from China and significant fiscal policy changes in Germany, which could shape Europe’s long-term economic trajectory. As a result, EUR/USD has climbed back above $1.09 and is edging closer to testing its yearly peak of $1.0955.
China’s economy has shown surprising strength, with industrial production expanding by 5.9% year-on-year in the first two months of the year, exceeding forecasts of 5.3%. Meanwhile, retail sales grew by 4.0%, up from December’s 3.7% increase, marking the most robust consumer spending performance since October. This resilience is encouraging for global trade and, by extension, the Eurozone, given its deep economic ties with China. Stronger demand from Asia, coupled with an improved market outlook, is providing broad-based support for the euro.
In Europe, Germany is set to implement major constitutional reforms this week, lifting restrictions on borrowing to finance defence spending beyond 1% of GDP. This shift signals a potential boost for the wider Eurozone economy, as increased government investment in defence and infrastructure could counteract existing growth challenges and bolster economic prospects.
With these tailwinds, the euro remains in an upward trend, benefiting from an improved risk environment and expansionary fiscal policies. However, its trajectory will depend on upcoming US economic data, particularly inflation figures and signals from the Federal Reserve, which could influence dollar sentiment. At the same time, expectations around European Central Bank policy remain a crucial factor—while markets anticipate rate cuts later this year, signs of economic resilience or increased government spending could challenge this outlook.
US Retail Sales Miss Forecasts as Economic Concerns Grow
Retail sales in the United States edged up by just 0.2% in February, falling short of predictions, while January’s figures were revised downward to show a sharp 1.2% contraction—the steepest decline since July 2021. Out of 13 retail categories, seven reported lower sales last month, though online retailers saw their strongest surge since late 2023.
Despite relatively stable economic data, warning signs of a potential slowdown are becoming more pronounced. For instance, manufacturing activity in New York state plunged, while input costs for businesses surged to their highest level in over two years. This suggests that rising tariffs may be dampening consumer spending while simultaneously stoking inflationary pressures.
Markets reacted mildly, with the dollar index slipping towards a five-month low and Treasury yields easing across the board.
The Federal Reserve now faces the difficult task of reassuring investors while acknowledging growing economic risks. Chair Jerome Powell is set to address the public on Wednesday after the central bank’s policy meeting, where interest rates are widely expected to remain unchanged.
Sterling's Outlook Tied to Interest Rate Expectations
Foreign exchange markets are heavily influenced by monetary policy, and while neither the Federal Reserve nor the Bank of England (BoE) is expected to lower interest rates this week, future expectations currently favour the pound. Market pricing suggests a roughly 75% likelihood of a BoE rate cut in May, compared to just 25% for the Fed. However, the US central bank is expected to implement more rate cuts overall by the end of the year. This shifting outlook has bolstered sterling due to an improving UK-US yield differential.
That said, sterling remains vulnerable to a shift in sentiment should inflation in the services sector and private-sector wage growth begin to ease significantly. For now, market participants are increasingly sceptical that the BoE can sustainably achieve its inflation target within its forecast horizon, with key breakeven inflation rates still exceeding 3%. Given the uncertain economic landscape—compounded by domestic fiscal policy measures and ongoing trade tensions—the BoE is likely to proceed with caution.
Amidst this uncertainty, sterling’s ability to break and hold above the $1.30 threshold may hinge more on a weakening US dollar, rather than domestic strength.
