• USD Softens: The U.S. Dollar Index (DXY) eased this week, influenced by stronger-than-expected eurozone growth and German inflation, reducing expectations for an ECB rate cut in December.
• Bank of Japan Surprise: USD/JPY dropped nearly 1% after BoJ Governor Kazuo Ueda signaled potential rate hikes, countering recent market expectations of a cautious BoJ.
• Limited Dollar Gains: Although the dollar has been strong on U.S. rate spreads and election positioning, less-dovish stances from the ECB and BoJ may limit further dollar upside.
• Euro Outlook: ECB hawkishness, combined with strong German and eurozone data, could support EUR/USD as it approaches recent highs, though U.S. election uncertainty may cap gains.
• UK Budget Wobbles Sterling: The UK’s expansionary budget initially lifted sterling, but concerns over high borrowing and Gilt issuance may limit gains, with potential longer-term support for EUR/GBP as BoE rate cuts loom.

USD: Dollar Retreats Amid Overseas Market Surprises

This week, the U.S. Dollar Index (DXY) softened slightly, with international developments taking center stage. Stronger-than-expected third-quarter eurozone growth and October German inflation data have shifted market expectations, reducing the likelihood of a 50 basis point rate cut from the ECB this December.

Adding to the dollar’s dip, the USD/JPY pair dropped nearly 1% following Bank of Japan (BoJ) Governor Kazuo Ueda’s press conference. Ueda outlined a potential plan for further rate hikes, surprising markets that had recently anticipated a more cautious BoJ due to political uncertainties in Japan and expectations of a dovish government.

In the dollar’s case, recent strength has been driven by expectations of a Trump election victory and U.S. rate spreads widening as other global central banks turn more dovish. However, signs that the ECB and BoJ may not be as dovish as expected could limit further dollar gains for now. Today’s core PCE deflator, the Fed’s key inflation gauge, came in at 0.3% month-over-month, likely insufficient to push the dollar higher in the current environment. DXY sits at 104.00 support, hinting that a modest pullback to 103.65 may be on the horizon.

EUR: ECB December Rate Cut Hangs in the Balance

Yesterday, hawkish voices at the ECB gained traction. Upside surprises in German and eurozone economic data, including October CPI for Germany, spurred markets to adjust expectations, now seeing only a moderate chance of a 50bp rate cut in December. ECB Board Member Isabel Schnabel’s comments against hastily cutting rates bolstered this shift, causing the two-year EUR/USD swap rate spread to narrow, which supported EUR/USD. A similar sentiment could drive EUR strength if eurozone October CPI data surprises again today, cutting rate-cut expectations further.

EUR/USD may retest yesterday’s high of 1.0870, but any attempt to reach 1.0903 could be limited by the upcoming U.S. elections.

GBP: Sterling Wavers as UK Budget Fallout Continues

The UK’s recent tax-and-spend budget, viewed by some as a return to “old Labour” policies, continues to impact UK markets. While sterling initially rose on the perception of stimulative effects and potential BoE rate repricing, our UK economist James Smith’s analysis suggests the Bank of England will likely not adjust policy in response to government spending plans. Short-term sterling rates may see a reversal of their recent jump.

Labour’s borrowing plans also face scrutiny, with new Gilt issuance close to £300bn projected for fiscal years 24/25 and 25/26. While EUR/GBP could dip based on short-term rate differentials, a slight fiscal risk premium may keep sterling supported. If eurozone CPI data today surprises on the upside, EUR/GBP may edge towards 0.8400. Over the longer term, EUR/GBP could trend higher, reflecting expectations of future BoE rate cuts and the budget’s fiscal risk premium effect on sterling.