Sterling Struggles Amid Rising UK Debt Concerns

GBP
Sterling’s recent rally has lost momentum, reflecting growing worries over the UK’s fiscal position. Last week, the pound surged above $1.37, buoyed by a dovish shift from the Federal Reserve and strong UK wage and services inflation data. However, it soon fell back below $1.35, despite the Bank of England keeping interest rates on hold. This pullback suggests that sterling’s upside potential may be fading, even with its relative yield advantage. Options markets indicate caution, showing a bias towards further weakness over longer maturities.

The pound’s vulnerability was highlighted by August borrowing data, which revealed a deficit of £18.0bn – the highest for that month in five years. Fiscal concerns are resurfacing, and against the euro, sterling has remained trapped in a narrow €1.1450–€1.16 range. While elevated front-end yields offer some support, risks from slowing growth, fiscal pressures, and stagflation persist.

The UK’s broader fiscal outlook also weighs heavily on the currency. Public borrowing for the current financial year is already £11.4bn above projections, as spending rises faster than tax revenue. Debt now stands at 96.4% of GDP, fuelling concerns about the government’s ability to manage issuance without unsettling bond markets. Unless Chancellor Rachel Reeves unveils credible measures in November’s budget, further sterling weakness appears likely, with markets bracing for either spending cuts or higher taxes.

USD
The US dollar is ending the third quarter around 1% stronger, reflecting a closer alignment between market movements and underlying economic conditions. Earlier in the year, the Fed’s hawkish stance had driven dollar gains, but that momentum has slowed. While fundamentals now provide less upward pressure, the dollar is no longer highly sensitive to negative news, particularly as tariff concerns have eased.

Recent trading shows the greenback reacting strongly to economic data surprises. Market sentiment has been shaped not only by positioning but also by fears that growth could weaken or inflation persist. A notable example was the Fed’s latest meeting: despite weak labour market data, the central bank maintained a firmer tone, prompting the dollar to recover its earlier losses and close slightly higher.

Traders will be closely watching the upcoming personal consumption expenditure (PCE) report for signs of easing inflation. A softer reading could weigh on the dollar, although support around the 97 level is expected to hold.

EUR
The euro saw gains last week, supported by shifts in relative interest rate expectations. With the European Central Bank (ECB) appearing to end its easing cycle while the Federal Reserve has only just started cutting rates, the balance tilts modestly in favour of the single currency. Markets currently expect at least two more US rate cuts, limiting the euro’s potential gains. Nevertheless, EUR/USD has held above 1.17, a noticeable improvement from its summer lows.

However, the euro remains heavily reliant on US weakness for further progress. With little fresh momentum from within the eurozone, investors are looking to disappointing American data to push EUR/USD closer to 1.18. This week, the European calendar is relatively light, with PMIs the main focus.

Looking Ahead
Currency markets are increasingly data-driven, with sentiment shifting sharply when results deviate from expectations. For the US dollar, upcoming inflation data will be crucial. Sterling faces mounting fiscal pressures and the risk of disappointing growth, with November’s budget likely to set the tone. Meanwhile, the euro depends largely on the Fed’s path and whether US data undermines the case for tighter policy.

As the final quarter unfolds, all three major currencies remain finely balanced, with incoming data and policy signals likely to dictate their direction more than long-standing narratives.

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