Sterling continues to be one of the most resilient major currencies this month, as strong UK data and rising Bank of England rate hike expectations underpin the Pound.
Yesterday’s UK job figures came in better than expected with the unemployment rate unexpectedly falling in the three months to August (4.7% vs previous/expected 4.9%) and wage growth ticked higher. Additionally, news that Chancellor Healey has ruled out hikes to capital gains tax at next week’s Autumn Budget has been particularly welcomed by markets. Meanwhile, this morning's UK inflation data has supported the rally in the Pound. Data showed that UK headline inflation (CPI) rose to 3.5% in September (up from 3.1% in August), which is its highest level since October last year. As expected, higher energy costs were the main culprit for the rise, with fuel the largest contributor.
More importantly, the data showed that core inflation, which strips out volatile items such as energy and food, also moved higher to 2.8% (from 2.6%). That's the part the BoE will be most focused on and it hints that price pressures might be broadening, which will likely keep the MPC committed to keeping a lid on spiralling prices. Markets had already been pricing in around a 96% chance of a 0.25% BoE interest rate hike in November and are now pricing in well over 100 basis points (1%) of hikes over the next 12 months, which has created a lot of fresh demand for GBP. Some analysts, however, are arguing that markets are getting too carried away with these expectations as conditions remain fragile in the UK and there’s not yet enough evidence to convincingly conclude that higher energy costs are feeding through into wider inflation.
Political uncertainty and the widening civil unrest in France have continued to weigh on the Euro. Yesterday, the 10-year French government bond yield tested 5% again. It remains unclear whether next year’s French budget will even clear parliament and, even if it does, it's likely to be so watered down that it does little to fix its deficit problem. Furthermore, European gas prices have also jumped above €90/MWh for the first time since late 2022, which is adding further pressure on the Eurozone economy. As things stand, selling Euros appears to be the path of least resistance for many traders.
As a result, the GBP/EUR has risen around 2% this month and trades at fresh 17-month highs this morning. The GBP/USD is up 2.5 cents from last week’s low and trades towards the higher end of where it’s been over the past 5-weeks. The EUR/USD remains towards the lower end of its recent range.
Looking ahead, next week's Budget is the next big test for Sterling. With the Pound now looking quite stretched after its recent run, any announcement that damages growth without a credible plan for getting the public finances under control could trigger a sharp reversal.