Bank of England Outlook Dampens GBP/EUR Sentiment

The British Pound remains under pressure against the Euro as markets brace for the Bank of England’s monetary policy decision on Thursday. The GBP/EUR exchange rate has stalled below the 1.18 level, despite a modest recovery in late April fuelled by easing global risk aversion and a temporary improvement in investor sentiment following softer rhetoric from U.S. President Donald Trump.

This recovery appears to have lost momentum, however, with GBP/EUR now drifting lower amid rising concerns over economic stagnation in the UK. The pair has proven highly sensitive to global equity volatility, and with markets now in a holding pattern ahead of new trade developments between the U.S. and China, the support from fading volatility has evaporated.

Technical indicators signal a short-term downtrend, with a risk of a more significant move lower should the Bank of England adopt a dovish tone. Expectations are rising that the Bank will cut interest rates this week and indicate the likelihood of a follow-up move in June. This would mark a shift from the current pace of quarterly cuts, potentially triggering a sharper reaction in currency markets. A break below the 1.1708 support level would pave the way for a decline toward 1.16.

The latest S&P PMI survey underscores the economic fragility, with April's composite index slipping to 48.2 — signalling contraction for the first time in over two years. The economic drag is attributed in part to fiscal tightening measures, including higher employer National Insurance Contributions and a minimum wage hike. While inflation pressures remain persistent, the Bank appears committed to its view that inflation will fall back to 2.0% in 2026, allowing it to focus on supporting growth.

GBP/USD: Consolidation Before the Next Leg Higher

The Pound has held its ground against the U.S. Dollar, even as the broader USD weakens amid continued domestic political uncertainty and a lack of conviction from market participants. GBP/USD reached a recent high at 1.3441 before entering a period of consolidation, finding strong support at 1.3234. This area has so far held firm, affirming the prevailing uptrend.

Despite mixed economic signals from both sides of the Atlantic, market sentiment remains broadly supportive of GBP/USD. A lack of significant U.S. data releases this week and underwhelming follow-through on last week's strong U.S. jobs report suggest the Dollar is lacking upward momentum. President Trump's unpredictability continues to inject uncertainty into markets, particularly around trade and fiscal policy.

The Bank of England’s upcoming policy decision could introduce short-term volatility, especially if a more aggressive easing cycle is hinted at. However, downside in GBP/USD may be limited due to rising inflation expectations, which could temper the BoE’s dovish stance. Should the Bank revise its inflation forecasts higher, this could offer a counterbalance to rate cut expectations and help Sterling recover.

Furthermore, easing energy prices are expected to reduce future inflationary pressures, adding complexity to the Bank’s policy balancing act. In the bigger picture, continued weakness in the U.S. Dollar — driven by long-term structural concerns and trade headwinds — supports the outlook for a renewed push toward and beyond 1.3440 once current consolidation resolves.

Dollar and yields rise despite lingering economic worries

The US dollar and Treasury yields moved higher on Thursday, buoyed by a slightly better-than-expected ISM manufacturing reading. However, lingering fears of stagflation kept markets cautious. Two-year Treasury yields broke a five-day losing streak, rebounding from the 3.6% level. Meanwhile, the US dollar index climbed toward its 21-day moving average in an effort to reverse the downward trend in place since early February. That rally has so far stalled ahead of today’s key US jobs data and next week’s Federal Reserve meeting.

April’s ISM manufacturing index dropped to 48.7, its lowest in five months, indicating continued contraction in the sector. While the headline figure wasn’t as disappointing as some had anticipated, the underlying details were mixed. Input prices rose but fell short of forecasts, and both new orders and employment figures improved slightly, yet remained below the 50 mark—suggesting ongoing weakness and reinforcing concerns over stagflation. The sector has faced persistent headwinds from elevated tariffs, and optimism has faded since Donald Trump’s presidency began, as businesses contend with falling demand and rising costs. Though the broader US economy has shown some resilience, risks are growing, particularly following a first-quarter GDP contraction—the first in three years—driven by a record surge in imports amid trade tensions.

All attention now turns to the April employment report, which is unlikely to fully reflect the recent impact of tariff-related announcements. The unemployment rate is expected to hold steady at 4.2%, while non-farm payrolls are forecast to rise by 138,000, a marked slowdown from March’s 228,000. A solid report would reduce the urgency for the Fed to lower interest rates next week or hint at future cuts. That said, early signs of labour market strain are emerging. According to the latest Challenger data, nearly 700,000 jobs have been cut over the past six months. As a result, May’s jobs data may come in significantly weaker, potentially increasing pressure on the Fed to support employment—posing another headwind for the dollar in the months ahead.

Euro heads for second weekly loss as risk appetite rises and geopolitical tensions linger

The euro is on track for its second consecutive weekly fall against the US dollar, pressured by stronger global risk appetite and lower market volatility, as investors grow more optimistic about potential trade agreements. Nevertheless, EUR/USD has managed to hold at its 21-day moving average so far, suggesting the broader uptrend remains intact for the time being. Market focus today is on flash inflation data from the Eurozone, with expectations that the headline rate will move closer to the European Central Bank’s 2% target.

In geopolitical developments, the euro found little support from the signing of a long-expected mineral deal between Ukraine and the United States. The agreement, which also saw the launch of a US-Ukraine investment fund presented by the Trump administration as a strategic and financial commitment, failed to shift sentiment. The euro is down 0.5% this week—its sharpest weekly drop since late March—and could fall further if US labour market data beats expectations, possibly driving EUR/USD below the $1.12 level if the 21-day average is breached.

Despite this pullback, the euro remains roughly 9% higher against the dollar for the year, trading well above its longer-term moving averages. Support for the currency continues to stem from a more favourable eurozone fiscal outlook and ongoing dollar softness. While tariffs may exert downward pressure on inflation and lead to further ECB rate cuts—potentially capping the euro’s gains—the region’s more supportive cyclical environment may play a greater role in shaping its longer-term performance.

Pound sees mixed fortunes as markets weigh global risks and domestic shifts

The British pound has delivered a varied performance this week, advancing most notably against the euro, New Zealand dollar, and Japanese yen—gaining over 1% against the latter following a notably dovish Bank of Japan update. Against the US dollar, however, sterling has held relatively flat near $1.33, while slipping against the Norwegian krone and Australian dollar.

Global sentiment continues to play a leading role in steering the pound. With equity markets staging a strong comeback and recovering all losses since “Liberation Day,” sterling has strengthened against traditional safe-haven currencies, excluding the dollar. Hopes of renewed trade dialogue between China and the US have further supported appetite for risk, helping to lift the pound in some crosses.

However, the outlook for UK interest rates has turned increasingly dovish. Markets are now pricing in four additional 25-basis-point cuts from the Bank of England this year, with the base rate expected to drop to 3.5%—the first time such pricing has been seen since last autumn. This repricing reflects concern that weakness in the US economy could have global repercussions. The pound, in turn, has come under pressure via falling rate differentials, diminishing its appeal to investors seeking yield.

Meanwhile, political developments have added a new layer of uncertainty. Reform UK, under the leadership of Nigel Farage, clinched a narrow win in the Runcorn and Helsby by-election—just six votes ahead after a recount. The result is a setback for Prime Minister Keir Starmer, whose Labour Party had secured the seat with a commanding majority in the 2024 general election. The outcome highlights growing unease within Labour ranks over the rising traction of the populist right, as Reform continues to build momentum in key regions.

Dollar strengthens despite economic headwinds and trade concerns

The US dollar extended its winning streak for a third consecutive day, buoyed by robust end-of-month buying activity, strong corporate earnings, and growing hopes that trade frictions may be easing. Investor sentiment has been lifted by President Trump’s recent remarks suggesting forthcoming trade agreements with India, Japan, and South Korea, along with continued optimism about reaching a deal with China. This shift in tone has lent support to the dollar, despite it recording its weakest monthly performance since late 2022—largely due to the growing momentum behind global moves to reduce reliance on the greenback.

However, the broader outlook for the US currency remains clouded by fresh economic data that point to increasing fragility. Figures released yesterday reveal that the US economy shrank by 0.3% in the first quarter of 2025—its first contraction since early 2022 and a marked reversal from the 2.4% growth seen in the previous quarter. A major contributor to the downturn was a dramatic 41.3% spike in imports, as companies rushed to secure goods ahead of expected tariff increases. This surge widened the trade deficit and led to a record 5 percentage point drag on GDP from net exports. Government expenditure also faltered, reducing growth by 0.25%—its first negative contribution in three years—while private sector spending fell significantly under the weight of growing uncertainty.

The rush to front-load imports, reminiscent of similar behaviour observed in previous tariff cycles, has further complicated the economic picture. These distortions have skewed headline indicators, exaggerating short-term volatility and making it harder to gauge the underlying health of the economy. While the downturn was broadly in line with expectations, the data underline persistent concerns about the direction of US economic growth.

The pace of consumer spending growth in the US slowed to just 1.8% in the first quarter of 2025—its weakest rate since the second quarter of 2023—highlighting growing pressure on household activity. This deceleration points to the likelihood of continued economic softness in the second quarter. The recent introduction of new tariffs on 2 April has yet to filter through into the economic data, but early signs suggest that consumers are already feeling the strain. The combination of trade policy uncertainty and a broader slowdown appears to be weighing increasingly heavily on domestic demand.

In addition, fresh inflation figures have given policymakers little reason for reassurance. The Federal Reserve’s preferred gauge of inflation—the Personal Consumption Expenditures (PCE) price index—rose by 2.3% year-on-year in March 2025. While this marks the slowest annual increase in five months, it still exceeded market expectations of a 2.2% rise. Compounding the picture, February’s reading was revised upwards to 2.7%. Although the pace of inflation is showing signs of cooling, the higher-than-expected print complicates the Federal Reserve’s policy calculus and has reignited concerns about stagflation, as slowing growth coincides with persistent price pressures.

Euro retreats from highs despite record-breaking April performance

April marked a historic milestone for the euro, delivering its strongest performance against the US dollar for that month since the euro’s introduction in 1999. However, gains proved fleeting as EUR/USD slipped below the $1.13 threshold this morning, following renewed optimism from President Trump over potential trade agreements with key international partners.

The revival in market confidence and growing belief that the worst of global trade tensions may have passed has put pressure on the euro in recent days. Interestingly, the single currency had been an unexpected beneficiary during earlier phases of trade uncertainty, favoured by investors as a relatively inexpensive and liquid alternative. Support has also come from the eurozone’s current account surplus and a notable fiscal boost from Germany’s landmark public spending initiatives. Although the euro has retreated from three-year highs, diverging economic signals from either side of the Atlantic continue to shape sentiment and may offer further scope for appreciation in the months ahead.

While the US economy unexpectedly contracted in the first quarter, shrinking by 0.3%, the eurozone expanded by 0.4%, fuelled by robust domestic consumption. Germany’s GDP grew by 0.2% as anticipated, while France recorded more modest growth of 0.1%.

Inflation dynamics within the euro area remain mixed. German headline inflation softened to 2.1% in April, though underlying price pressures ticked higher. In contrast, France’s annual inflation rate held steady at 0.8%. Financial markets are increasingly confident that the European Central Bank will ease policy further, with expectations currently pointing to a rate cut in June and a total of 67 basis points of reductions by the end of the year.

GBP/USD hovering near 38-Month high as market momentum shifts

The pound is trading just below $1.34 this morning, holding close to its highest level in over three years after briefly touching that mark on Tuesday. This recent strength has been fuelled by a broadly weaker US dollar and calmer market conditions. With a 3.8% gain so far in April, sterling is on track for its best monthly performance since November 2023.

However, against the euro, the picture is less favourable. Sterling is heading for a second consecutive monthly decline of around 1.5%, the sharpest two-month drop since the latter part of Q3 in 2022.

The UK’s limited exposure to current US trade restrictions—temporarily suspended until July—has helped mitigate some external risks. In fact, the US is expected to run a $12 billion goods surplus with the UK this year, standing in contrast to trade deficits with China and the EU. Still, Britain’s heavy dependence on global trade and investor sentiment leaves it exposed. Recent flash PMI data showed UK business activity has fallen to its lowest level in three years.

The Bank of England’s cautious stance on interest rate cuts—markets are pricing in 85 basis points of easing this year—has lent some support to the pound. Yet, correlations between FX and rates markets have become increasingly unreliable.

Technical signals such as the relative strength index suggest the pound's rally against the dollar may be losing traction. Even so, rising concerns over the health of the US economy—and the waning dominance of the “American exceptionalism” narrative—could give GBP/USD further upside potential, especially if upcoming US data underwhelms.

Dollar steadies for now, but economic headwinds strengthen

The US dollar has recently levelled off, following President Trump’s partial retreat from aggressive policy stances on the Federal Reserve and trade. While this has helped calm markets temporarily, the broader pressures on the dollar remain firmly in place. Rather than fears about the dollar’s role as a global reserve currency, the real concern lies in the potential for a sharp US economic slowdown, driven by trade disruptions and increased uncertainty.

Recent data points suggest mounting risks. Investors are closely eyeing the first-quarter GDP figures due today, against a backdrop of weakening indicators. Job openings have disappointed, though a reduction in layoffs offers a modicum of reassurance. However, consumer confidence has taken a notable downturn, reaching its weakest level since May 2020. The expectations index has plunged to levels last seen in 2011, reflecting widespread anxiety largely triggered by the newly introduced global tariffs, which rattled markets when announced and continue to cast a shadow over the economic outlook.

The labour differential—measuring the gap between jobs being plentiful versus hard to get—has also slipped to a six-month low. Still, this isn’t ringing alarm bells yet. Markets have shown limited reaction so far, though that may change quickly if job losses begin to accelerate. All eyes are now on Friday’s jobs report, which could prove pivotal.

Meanwhile, the trade picture is showing signs of strain. March saw the US goods deficit hit a record $162 billion, well above forecasts, as import volumes surged. This rise reflects a pre-tariff buying spree by businesses and consumers attempting to beat the 2 April tariff deadline—highlighting how policy signals are already having tangible effects on trade dynamics and economic data.

Euro climbs as broader shifts undermine Dollar

The euro is on course for its best monthly rise since late 2022, though some near-term volatility could emerge—particularly if month-end investment flows rotate back into the US dollar, following weaker US equity performance and dollar softness throughout April.

The drivers behind the euro’s advance extend well beyond interest rate dynamics. Global markets are now navigating a far more intricate backdrop, shaped by political uncertainty, policy divergence, and a slow but steady shift away from the US dollar in global trade and finance.

While there has been a cooling in short-term euro enthusiasm, positioning in currency options suggests this is temporary. Traders are signalling renewed appetite for euro strength, as seen in the widening spread between one-week and one-month risk reversals. Longer-dated contracts are also leaning more bullishly, with one-year risk reversals nearing their firmest levels since September 2020.

The single currency’s strength is not solely down to optimism around the eurozone. Germany’s recent fiscal stimulus announcements gave the initial lift, but the real engine behind the euro’s rise has been sustained dollar weakness. As investors reassess global currency trends, the idea of EUR/USD reaching $1.20 this year is gaining increasing support.

Looking ahead

For the remainder of the week, FX markets are facing a mix of event risks and underlying structural factors. Key economic data, particularly Friday’s Non-Farm Payrolls report, will likely influence expectations around US interest rates and the US dollar’s trajectory. In addition, releases such as the ISM Services PMI and Initial Jobless Claims will provide further insight into the US labour market and inflationary trends.

Month-end portfolio rebalancing flows could lead to temporary volatility, especially if equity weakness or bond buying persists, potentially affecting the USD and other currencies.

With GBP/USD near a 38-month high and EUR/USD continuing its upward movement, markets remain sensitive to technical resistance levels and shifts in investor positioning, which could result in profit-taking and short-term reversals.

In the background, ongoing tariff wars and trade policy uncertainties will continue to affect market sentiment. These tensions, particularly between the US and key trading partners, may keep volatility elevated as businesses and investors adjust to the shifting landscape. Additionally, geopolitical risks, such as instability in the Middle East and Ukraine, may drive demand for safe-haven currencies like the USD, JPY, and CHF.