Last week saw a rebound in the GBP, buoyed by improved risk sentiment, stronger-than-anticipated UK economic data, and relatively hawkish remarks from certain Bank of England (BoE) policymakers.  These factors offset some dovish comments from the preceding week, bolstering the UK currency.  Consequently, money markets scaled back expectations of BoE rate cuts, leading to a shift away from fully pricing in a starting point in August. The UK 10-year government bond yield surged to its highest level in five months.

Looking ahead, we anticipate the GBP/EUR recovery to stabilise above 1.1650 at interbank, potentially testing levels above 1.17, particularly if Eurozone inflation figures come in weaker than expected.  However, both the Eurozone and UK economies face similar prospects, suggesting that central banks are likely to adjust rates more or less in sync, limiting significant trend shifts in the near term.

Any shortfall in Eurozone inflation could prompt the European Central Bank (ECB) to cut interest rates again in July, following its move in June.  The timing of this potential second cut is crucial for markets, considering the well-anticipated June action. Conversely, if inflation figures surpass expectations, the EUR could rally against GBP and USD, as markets would perceive a reduced likelihood of a July rate cut.  A strong inflation print might even cast doubt on the appropriateness of a June cut, further supporting the EUR.

In the US, a slew of market-moving releases, including the Employment Cost Index, ISM manufacturing and services PMI, job openings, factory orders, and the nonfarm payrolls report, will shape market sentiment throughout the week, culminating with the Friday report.  

These incoming data points are pivotal in assessing the trajectory of the US economy, especially as the Atlanta Fed's Nowcast for Q2 US GDP sits at an elevated 3.9%.  Investors anticipate Federal Reserve Chair Jerome Powell to reiterate the central bank's neutral stance in response to higher-than-expected inflation in Q1 during Wednesday's meeting.  However, given the widespread expectation of unchanged policy, attention will likely focus on the Treasuries Quarterly Refunding Announcement (QRA) preceding the FOMC meeting.

Despite retreating from its recent one-week peak above $1.25 yesterday, GBP/USD remains poised to record its most substantial weekly advance in seven weeks. A more balanced tone from Bank of England (BoE) policymakers this week, alongside a string of robust UK economic indicators, notably consumer confidence this morning, have bolstered the pound across the spectrum.

The GfK consumer confidence gauge in the UK surpassed expectations, climbing to -19 in April from -21 in March. Over the past half-year, the composite index has fluctuated between -24 and -19, reflecting sluggish progress amid economic uncertainties. Despite the recent uptick in the UK's unemployment rate to a six-month high, inflation has retreated from nearly 9% to around 3% over the past year, resulting in the UK Misery Index (unemployment + inflation) plummeting to its lowest level since 2021. Given the strong correlation between consumer confidence and the Misery Index, we anticipate a further boost in morale, particularly once the BoE initiates interest rate cuts.

Markets are currently pricing in a mere 40 basis points of rate cuts by the BoE this year, with the initial adjustment anticipated in August. However, we wouldn't be taken aback by a reduction as early as June, possibly totalling 75 basis points for the year, which could cap any GBP appreciation due to unfavorable yield differentials. Nonetheless, absent any intervention from Japanese authorities, GBP/JPY could extend its ascent to new highs not seen since 2015. Following unexpectedly low Japanese inflation figures, the Bank of Japan opted to keep rates unchanged this morning, exerting pressure on the yen across the board.

The USD bounced back after Tuesday's PMI slump, surprising markets with diverging business surveys compared to Europe.  This raised doubts about the idea of US economic superiority, but didn't significantly change the monetary policy outlook. Money markets still anticipate less than two quarter-point rate cuts by the Federal Reserve (Fed) this year, with even a slim possibility of a hike.

While soft data like PMI surveys offer insights into economic trends, they haven't been as influential on markets as hard data, particularly inflation and employment reports.  Therefore, today's US GDP figures, Friday’s PCE inflation report, the upcoming Fed meeting, and jobs data next week will play crucial roles in determining whether the Fed maintains its current policy stance, potentially keeping rates higher for longer and sustaining the dollar's strong performance in 2024.  The USD is expected to continue benefiting from its status as a high-yielding, high-growth, commodity-backed safe haven currency. However, this week's price movements, combined with the overcrowded speculative bets on USD appreciation, raise doubts about the extent of further USD gains, especially with USD/JPY hitting fresh 34-year highs amid growing concerns about Japanese intervention.

Historically, current levels of core, medium, and trimmed inflation momentum have been associated with Fed rate hikes rather than cuts.  Options markets now indicate approximately a one in five chance of a US rate hike within the next 12 months.  If this probability increases or if there's another external shock, such as heightened geopolitical tensions in the Middle East, demand for the dollar will likely remain strong.

GBP maintained its recent gains against the EUR and USD yesterday, buoyed by a survey indicating that British manufacturers are gearing up to increase output in the coming months, driven by growing confidence. GBP/EUR has climbed back above its 200-day moving average support level, although it remains nearly 1% below last week's peak of €1.1735. Meanwhile, following its strongest daily surge of 2024 on Tuesday, GBP/USD is edging closer to $1.25.

The Confederation of British Industry’s (CBI) quarterly Industrial Trends survey revealed that business optimism reached its highest level in almost three years, while sentiment within the manufacturing sector improved significantly, with output expectations hitting a six-month high. However, pressures on prices continued to mount, with the corresponding index reaching its highest level since February 2023. While this data didn't significantly impact the pound, coupled with the positive UK PMI surveys earlier in the week, it suggests a brighter economic outlook for the UK in the long run, which should support the sterling. However, in the short term, a growing disparity in the interest rate outlook between the UK and US could weigh on GBP/USD. Currently, less than two 25 basis point rate cuts are anticipated by both central banks, but there's potential for a more dovish repricing by the Bank of England (BoE), particularly if it acts before the Federal Reserve, a scenario that is becoming increasingly plausible.

Market sentiment has slightly shifted against the prevailing notion of policy divergence that had propelled the USD upwards this year. Despite ample evidence of the US economy outperforming its global counterparts, recent business activity data from S&P Global indicates a slowdown, with US activity expanding at its slowest pace in four months in April.  Consequently, money markets have adjusted their expectations towards the likelihood of two quarter-point rate cuts by the Federal Reserve (Fed) in the current year, leading to declines in US yields and a broad weakening of the US dollar.

The flash composite Purchasing Managers Index (PMI), which monitors both manufacturing and services sectors, fell to 50.9.  While a reading above 50 still signifies expansion in the private sector, it marks the slowest growth since December 2023, suggesting that the US economy may not be as robust as previously believed. Furthermore, the composite measure of orders revealed the first contraction in six months, while employment declined for the first time since June 2020, particularly affecting the services sector.  This softening in the labour market has also dampened price pressures, with both input costs and output charges rising at slower rates.

As the USD continues to recoup losses, traders are eyeing Thursday's US GDP report and Friday's March data on the Fed's preferred inflation gauge, the PCE deflator.  Should these indicators fall below estimates, it's likely to exert further downward pressure on the USD.

According to recent flash PMI data, the UK economy's recovery from recession unexpectedly accelerated at the beginning of the second quarter.  This data preceded relatively hawkish comments on monetary policy from Huw Pill, the chief economist of the Bank of England (BoE).  These developments, coupled with weaker US PMI figures, contributed to the largest daily rise (0.8%) of GBP/USD so far this year and saw GBP/EUR surpass its 200-day moving average above €1.16.

The decline in inflation and subsequent strong rebound in consumer real disposable income are driving growth in the UK.  The UK composite PMI climbed to a robust 54.0 in April, exceeding expectations and marking the strongest expansion in business activity since May 2023. Notably, the UK has consistently outperformed the US every month this year.  The increase was led by a significant upturn in the services index to 54.9 from 53.1, offsetting a downturn in manufacturing to 49.1 from 50.9. Meanwhile, firms reported the slowest rise in prices charged in over three years, yet they also faced the strongest cost pressures in 11 months, particularly from staff wages following the 9.8% minimum wage hike in April. This raises concerns that despite headline inflation nearing the 2% target, the battle against inflation pressures may not be over. Indeed, Mr. Pill highlighted the greater risks of cutting rates too hastily, even as inflation approaches target levels.