Friday saw GBPUSD rise to a high of $1.2771, but the rally was relatively short-lived, and difficult to explain when looking at the lack of interesting UK macroeconomic data or surveys and compared with a headline improvement in the US. 

The pound rallied against the EUR also, rising to a high of €1.1629 before slipping back a little. Was this a continuation of the positivity for the GBP, or a series of problems for the other economies? I’m going to suggest it was far more the latter than the former, since although there was a bit of positive news from the UK in the form of a stronger final December services PMI (Purchasing Managers’ Index) reading, that survey is inconsistent with data and other recent surveys. 

The challenge for the GBP comes at the end of this week, with the release of UK activity figures for November. Could we see more weakness in manufacturing, services and construction, making a second quarter of negative growth a greater probability? I think the risks are that the UK economy will continue to struggle, and although there have been signs of improvement in terms of mortgage finance costs and a rise in house prices, activity around consumer spending is set to remain under pressure into the early part of 2024. 

Could any weakness in November activity figures have been masked by heavier price discounting by retailers to boost volumes? What might all this mean for the timing of any Bank of England interest rate cuts, and what could the scale of rate cuts be in 2024? As for the GBP, are there risks of a sell-off, with USD and EUR buyers taking advantage of the recent rebound?

Last week saw US Federal Reserve interest rate cut expectations continue to converge towards May for the first cut. The markets expect that interest rates will fall to around 4% by the end of 2024. That may be underestimating the extent of any interest rate cuts, if the inflation rate continues to fall and signs of labour market loosening intensify. 

However, the markets are already pricing in far more interest rate cuts from the Federal Reserve than the other major economies, and I think this is where that might be an opportunity for renewed USD strength. 

Given the relative macroeconomic performance of the US, UK and Euroland, there might be more rate cuts coming from other central banks versus what is priced in. Moreover, as we’ve seen in previous crises, what might begin in one economy tends to spread to others, so the consequences of problems in the US might be felt worldwide. 

The USD might end up performing more strongly than it did over the course of Q4 2023, and this week’s release of CPI (Consumer Price Inflation) and PPI (Producer Price Index) figures for December will likely prove the next challenge for the weak USD narrative. What happens if headline and core inflation measures don’t fall by as much as expected?

Towards the end of last year, the EUR made some renewed headway against the USD, but it looked like USD weakness given the performance of other majors at the same time. Furthermore, the macroeconomic news was very disappointing from Euroland, with more signs of weak activity across a range of releases (industrial production, retail sales etc). Survey news has improved slightly, but only from a low base, which suggests to me that the scale of activity declines is slowing, rather than there being a more general improvement in activity. 

So is there much for the EUR to latch onto and generate unilateral strength, or will it continue to be beholden to USD appetite being weakened by Fed rate cut expectations? I think it’s the latter and therefore believe that the EUR’s upside is limited against other majors such as the GBP, JPY, CHF etc. for the near term at least. 

The EUR may not even do particularly well against the USD, given recent months have encountered resistance in the $1.10 region. This week’s industrial production figures from the likes of Germany, France and other major states aren’t likely to be EUR-supportive either, in my opinion.

This week sees the central banks of Poland, South Korea and Peru make their latest decisions on monetary policy. The NBP (National Bank of Poland) and the BoK (Bank of Korea) are expected to leave policy rates on hold, with the NBP thought to have front-loaded cuts for a number of months when they cut by 100 basis points over the course of two meetings (September and October). 

The BoK could dial back its rhetoric towards potential further policy tightening, but it’s far too soon to expect interest rate cuts, in my view, despite the problems in other economies (China) that could undermine activity in the region more widely. 

The BCDP (Banco Central de Reserva del Peru) is expected to cut interest rates again, but this time the cut could be 50 basis points rather than 25. A big fall in the headline inflation rate gives the BCDP room for easing, although it may run out of room quickly (in terms of the effect on the Peruvian sol) if there aren’t cuts forthcoming from the Fed over the timescale expected.