FX Daily: Sterling succumbs to macro pressure

FX markets have had a quiet start to the week. The risks of new Russian sanctions highlighted here yesterday were actually less harsh than expected in that they gave Russia 50 days to reach a deal (ceasefire with Ukraine). Energy prices ended a little lower. And overnight, we've probably seen a couple of risk-positive developments. China's second-quarter GDP was a little stronger than expected, and Nvidia seems confident it will be able to start exporting its H20 chips to China again – confirming a thaw in US-China relations. Equity futures are called a little higher today. On the subject of equities, we start to see second quarter US earnings releases today, with JPM, Citi and Wells Fargo all reporting. Expectations are that trading income will offset moribund investment banking and deliver some decent results.

The main event, however, is the release of June CPI. Our rate strategy colleagues discuss its impact on their markets here. For FX, the reaction should be balanced in that any higher/lower deviation from the 0.3% MoM consensus should lead to a higher/lower dollar. For reference, the US interest rate curve still prices 16bp of Fed easing in September, a move we think will be priced out over the coming months.

We have a slight bias that DXY can edge to fill a gap to 98.35. Though a sub-consensus CPI would prove a setback.

Elsewhere, we've got Canadian June CPI today. Any downside miss can bring forward the expectations of the final cut in the Bank of Canada cycle and soften the CAD. Please see all our latest FX forecasts in the July edition of FX Talking.

Chris Turner

EUR/USD is consolidating as investors price up the next trade move. So far, the bloc has refused to retaliate and hopes to negotiate its way out of the 30% tariffs imposed by President Trump at the weekend. Failure to get that rate negotiated lower (prior expectations were that it could be negotiated down to 10%) would look negative for the region. But clearly it's going to be a noisy couple of weeks, and one can't rule out the threat of even higher US tariffs as Washington tries to get the deal over the line.

For today, US CPI will be the main driver of EUR/USD. But before that, we'll get an update on German ZEW investor expectations. These should come in on the strong side as investors focus on the medium-term benefits of German fiscal expansion. On the subject of fiscal policy, France is still dealing with large budget deficits and Prime Minister Francois Bayrou is due to unveil his fiscal consolidation plan today, including EUR40bn of spending cuts. Let's keep an eye on French government bonds, where failure to deliver spending cuts (e.g. the UK recently) seems to take its toll on local fixed income and FX.

EUR/USD is sitting above modest support at 1.1650. The FX options market prices a 59 pip EUR/USD range today. Let's see whether June US CPI can add a little momentum to this bull market correction.

Chris Turner

In quiet markets, the EUR/GBP run-up to 0.8700 has been notable. This softness in sterling has not been driven by the fiscal side. In fact, the 10-year Gilt-Bund spread has narrowed back into 187bp – the tightest since early April. No, it has been the narrowing in shorter-dated interest rate spreads that is weighing on the pound. Here, the two-year EUR:GBP swap differential has narrowed back into 157bp as investors question whether the Bank of England will have to ease policy faster than once per quarter. On that subject, we'll hear from Bank of England Governor Andrew Bailey tonight at 22CET as he delivers his annual Mansion House speech alongside Chancellor Rachel Reeves. Expect Governor Bailey to reiterate a position – similar to the Fed – that faster easing is possible if the labour market deteriorates.

On this latter point, after tomorrow's release of June CPI, Thursday sees some important UK labour market data. Should the May payroll release of -109k stay unrevised and should there be further payroll declines in June, UK rates and sterling could see another leg lower. Our forecast preference had been for EUR/GBP to grind towards 0.88 over the coming quarters. That could come a lot sooner if the labour market weakens.

Chris Turner

Today we get the final June inflation numbers for Poland, which will be followed by core inflation tomorrow. The flash estimate showed a slight drop from 4.3% to 4.1% YoY. On the other hand, core inflation should show a slight pick-up from 3.3% to 3.5%. However, more interesting will be the inflation prints in the months ahead. At the end of this month, we will see the July number, which we think could be close to the 2.5% inflation target. At the same time, we believe the central bank may be surprised further on the downside despite a forecast revision in that direction in July. Additionally, the economy continues to show downside surprises in the monthly hard data, with more expected next week. So, overall, we still see a dovish case for PLN.

We have been bearish on PLN since the July National Bank of Poland meeting and the surprise rate cut. Although PLN has been underperforming the region in recent days, usually markets fade the move quickly and the PLN depreciation does not last too long. Still, since the last NBP meeting, we haven't seen much of a local story and only the numbers from the economy and July inflation will be of more interest to the market. We still believe that dovish numbers will lead to more NBP rate cuts, more than the MPC now indicates in the interview and 50bp in September is on the table. Overall, we should see constant pressure on PLN to weaken in the coming weeks and we still see a target of 4.280-290 EUR/PLN.

Frantisek Taborsky