Euro rally extends as ECB poised to cut rates

The euro extended its advance against the US dollar this morning, though it remains in overbought territory based on the daily relative strength index. While the broader outlook continues to favour the euro in the medium term—supported by capital shifting away from the dollar—the European Central Bank (ECB) may look to curb its strength, with a rate cut expected.

EUR/USD has climbed roughly 5% this month, reaching new three-year highs, while EUR/CNY has gained 6% since the ECB’s March meeting, hitting its highest level in a decade. The weakening of the Chinese yuan relative to the euro raises questions about whether it can still provide a competitive edge for Chinese exports to the EU, particularly as US-China trade is expected to decline sharply due to escalating tariffs. President Trump’s tariff strategy is designed to pressure US trading partners into limiting their engagement with China—a policy Europe may consider as it grapples with a growing trade deficit with China since 2020.

The ECB is widely expected to reduce interest rates by 25 basis points today, pointing to heightened growth risks stemming from US trade policy. While rates may be nearing neutral, further reductions remain possible if tariffs intensify. However, the historical link between exchange rates and interest rate differentials has weakened since "liberation day", and the ongoing shift from US to European assets could keep EUR/USD supported around the $1.13 level, even if the ECB adopts a more dovish stance.

Pound holds firm against Dollar but remains weak versus euro

The pound continues to perform well against the US dollar but has lost ground against the euro, following UK inflation figures that came in lower than expected. The data offered temporary relief to the Bank of England (BoE), which is preparing for the potential economic impact of President Trump’s tariff measures.

Sterling has edged towards the $1.33 level against the dollar but remains under pressure in the EUR/GBP pair. As a reserve currency, the pound has been swept up in the broader decline of the dollar. However, the euro is benefitting from greater liquidity and a strong flow of repatriated capital into the Eurozone, bolstered by its substantial trade surplus with the United States.

The pound’s 2.8% monthly gain against the dollar reflects broader dollar weakness rather than underlying strength in sterling. Against its G10 counterparts, the pound has weakened versus six currencies and posted gains against only three. A convincing rally in sterling would typically involve broader strength, particularly against the euro.

So far, however, sterling has underperformed the euro, reflecting elevated volatility similar to that seen during the early stages of the pandemic. Should volatility subside, the pound could begin to recover ground against the single currency, supported by the UK’s relative resilience to tariffs and a stabilisation in domestic demand indicators.