Pound Under Pressure Despite Hotter UK Inflation

Sterling briefly gained ground on Wednesday after UK inflation came in hotter than expected, but momentum quickly fizzled as investors weighed the risk of stagflation. The pound struggled to hold above $1.35 against the dollar, while GBP/EUR hovered near €1.16 – highlighting how fragile the currency’s rate-driven rally has become.

Headline inflation accelerated to 3.8 per cent in July – the highest reading since January and above market forecasts of 3.7 per cent. Transport costs were the biggest driver, with airfares soaring more than 30 per cent and pushing overall transport inflation to 3.2 per cent, up sharply from 1.7 per cent the previous month.

More concerning for the Bank of England was the rebound in services inflation, which jumped back to 5 per cent, alongside evidence of broader price pressures across the CPI basket. Over 40 per cent of components are now running above 4 per cent, and more than 20 per cent are above 6 per cent – a stark contrast with last year, when no category reached that level.

The figures raise uncomfortable questions about whether the Bank moved too quickly in cutting rates earlier this month. Market expectations for another cut before year-end have already been dialled back, with the probability of a reduction by December slipping to around 42 per cent from 50 per cent just a day earlier. Yet even if policy remains on hold, concerns about fiscal stability and sluggish growth continue to cap sterling’s upside.

Dollar Finds Support as AI Optimism Cools

Across the Atlantic, the US dollar has steadied, rising around 0.5 per cent against a basket of major peers so far this week. The move follows a sharp pullback in technology shares, with Nvidia down 3.5 per cent on Tuesday and dragging the Nasdaq Composite 1.4 per cent lower – its second-worst session since April’s tariff shock. Investor enthusiasm for artificial intelligence appears to be cooling, putting the brakes on the tech-fuelled rally.

Despite a weak first half of the year, the scale of the dollar’s decline has often been exaggerated. Latest US Treasury International Capital (TIC) data showed foreign holdings of Treasuries hit a record high in June, challenging the “sell America” narrative linked to political risks. At the same time, volatility remains muted, credit spreads tight, and emerging markets continue to draw inflows – all pointing to ongoing appetite for risk.

Geopolitics is also providing a cautious tailwind. Recent high-level meetings have lifted hopes of progress on peace in Ukraine, though key territorial disputes remain unresolved. If energy markets stabilise, sentiment across Europe and emerging economies could improve further.

The dollar’s rebound may prove short-lived if the Federal Reserve minutes, due later today, reveal stronger support for rate cuts. Markets are still pricing in two to three reductions this year, with the Jackson Hole symposium later this week seen as a potential turning point. Last year Chair Jerome Powell used the event to signal a significant policy shift – even a subtle hint this time could reset USD positioning.

Euro Holds Steady Ahead of PMI Data

The euro remains rangebound, with EUR/USD moving less than 0.5 per cent in either direction in recent days. Despite a 12 per cent gain year-to-date, momentum has faded, with the pair anchored near its 21- and 50-day moving averages.

All eyes are now on Thursday’s eurozone PMI releases, which will be crucial in gauging whether business confidence is faltering in the wake of the new US–EU trade agreement. The latest ZEW survey already raised concerns: German economic sentiment tumbled 18 points to 34.7, while the current conditions index dropped to -68.6 – both far worse than expected. Weak Q2 growth in key sectors such as chemicals, autos and engineering has added to the gloom.

Although EUR/USD volatility is low and the pair remains stuck in a narrow range, a downside surprise in PMI data could tilt sentiment towards caution. Nonetheless, the longer-term outlook for the euro is still constructive. Growth differentials are once again becoming a central driver, with Europe’s slowdown proving less severe than feared and fresh fiscal stimulus expected to boost GDP from late 2025. In contrast, US resilience could fade as the year progresses – a divergence that may re-emerge as a source of euro strength in the quarters ahead.

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