GBP

Sterling tracked the euro very closely throughout the holiday period, in the absence of market-moving news, with the brief move in GBP/USD below the 1.24 level driven almost entirely by dollar strength. The dovish tilt in the Bank of England’s December communique, which unexpectedly showed that three MPC members voted in favour of an immediate interest rate cut, has created a near-term downside risk for the pound. Markets are, however, still taking the view that any policy cuts in 2025 will be gradual, and this has allowed GBP to hold its own against the common currency.

This week looks set to be a relatively quiet one, with only a handful of second-tier data expected. We maintain a constructive outlook on the pound. A decent macroeconomic performance, the likelihood of better relations with the EU under the Labour government and a still very attractive valuation, historically speaking, should continue to support sterling.

EUR

The common currency continued to lose ground against the dollar over the holiday period. There was little news of note out of the Eurozone, although hawkish noises from Federal Reserve officials, which have voiced concern over stubbornly high inflation, helped drive US rates higher and dragged the dollar along for the ride.

The gap between market expectations for ECB and Fed rate cuts remains wide, and the euro is struggling as a result. Tuesday’s inflation data will be key to gauge the extent to which the ECB can realise the market’s generous expectations for cuts during 2025. Another 25 basis point cut appears effectively set in stone for the bank’s January meeting, although investors will be far more interested in any comments from President Lagarde that could provide clues as to the possible level of the bank’s terminal rates.

USD

The relentless rise in interest rates as prospects for generous Federal Reserve cuts diminish will be tested this Friday by the latest US labour market report. High frequency jobs indicators, such as the weekly jobless benefit claims, show no signs of deterioration, and we expect another month of solid, albeit unspectacular, job creation.

The key number in our view will be the evolution of wages. These have grown for the last few months at a monthly pace of 0.4%, nearly 5% in annualised terms. However, with just one-and-a-half 25bp cuts priced in for all of 2025, a lot of US economic strength, and inflationary pressures, is already in the price of an extremely expensive US dollar. For this reason, we could see a sharp pullback in response to any data disappointment out of the US.