A big week ahead – Sterling Update

GBP

Similar to the other dollar majors, GBP/USD has been on a straight-line decline for the best part of nine weeks now after hitting 1.3126 in the middle of July. However, this week, the decline has been modest, and as of Thursday afternoon, it looks like the pound could finish the week reasonably flat, putting at least a temporary pause on that longstanding decline. GBP/USD is currently trading at just over 1.2330 and GBP/EUR at 1.1660.

Aside from the strong greenback (see USD), soft incoming UK data has been further fuelling the sterling’s decline. Last week’s comments from Bank of England Governor Andrew Bailey, suggesting that the BoE are nearing the end of its interest rate hiking cycle, also gained some believability throughout the market this week after another batch of weak-looking updates.

The latest UK employment report was released on Tuesday, which highlighted wage growth is now rising at a faster pace than inflation for the first time over two years. UK wages (excluding bonuses) rose by 7.8% on an annual basis over the three-month period from May to July, which is good news for employees who have been struggling to cope with the effects of surging inflation, fuelling significant rises to their cost of living. However, the overall unemployment rate also unexpectedly rose from 4.2% to 4.3% over the same period, with overall vacancies now falling below a million for the first time in nearly two years. This could suggest that the Labour market may now be beginning to turn.

Just a day later, the latest UK growth data also looked particularly soft, which may give the clearest signal to the BoE after GDP shrank by 0.5% during July. Markets had been expecting a dip of around 0.2% for the period. Furthermore, Manufacturing and Industrial Production saw sharp declines over the last month.

The BoE will make its latest decision on rates next Thursday, with the outcome far more uncertain after the recent soft data. However, the latest UK inflation data could still tip the pendulum one way or another when it’s released just a day before. In the meantime, expect GBP/USD to tag along with the broader dollar moves.

EUR

After much speculation, the ECB raised the key Euro area interest rates by another 25bps yesterday, marking its tenth successive rate hike, moving the deposit rate to a record high of 4%. However, at the same time, the ECB downgraded growth forecasts for the region and upgraded the outlook on inflation.

The revised growth outlook saw the ECB cutting its previous forecast for every year until 2025, with the central bank now expecting the economy to expand by just 0.7% this year and around 1% next year, a figure revised down from 1.5% previously.

With its ‘dovish hike’ suggesting that the ECB may have reached its peak rate in this cycle, EUR/USD slipped from around 1.0740 to 1.0640 in a relatively rapid decline as markets reacted to the news.

Rising energy prices fuelling upside risks to headline inflation are thought to be the reason behind the ECB’s rate hike. However, President Lagarde also appeared to hint that this could be the last hike in the tightening cycle, although falling short of confirming the terminal rate had been reached. Lagarde told reporters: “The focus is probably going to move a bit more to the duration, but it is not to say — because we can’t say — that now that we are at peak.”

Ahead of yesterday’s ECB meeting, Regional Industrial Production declined by over 1% during July, and there was a mixed German ZEW survey, with the Current Situation deteriorating significantly from -71.3 to -79.4. However, Economic Sentiment improved from -12.3 to -11.4. Looking ahead, we’ll be keeping an eye on next week’s regional inflation data updates.