eports in German newspapers that EU negotiator Michel Barnier sees support for a two-year transition deal buoyed Sterling, which had been beat up over the previous weeks to rather cheap levels. The Dollar lost ground after the US September inflation report indicated that the rebound in headline inflation has not yet translated into upward pressure on core prices. The net result was a Dollar sell-off, which lost ground against every other G10 currency save the Swedish Krona, and a significant bounce in Sterling.

Politics will dominate trading in FX markets this week. There will be significant developments around the Catalonia conflict as the deadline for the separatists to respond to Madrid on whether independence has been declined expires this morning. The Spanish Government is almost certain to suspend home rule this week, in our view, and this may pressure the Euro lower. The Japanese election is unlikely to have a major impact on the Yen, and there may be news on the renegotiation of the NAFTA free trade agreement that could impact the Mexican Peso.

Major currencies in detail

GBP

Brexit negotiations saw the first real sign of progress in quite some time last week. EU negotiator Michel Barnier is said to be leaning towards supporting a two-year transition deal, whereby the UK membership in the single market would expire two years after the March 2019 deadline in order to allow more time for negotiating a post-Brexit deal.

Sterling faces a key test this week, with September inflation released on Tuesday and employment data out on Wednesday. Markets are pricing in a 3.0% print in headline inflation, which in our view will seal a Bank of England hike at the November meeting and provide further fuel for the Pound rally against the Euro.

EUR

As we are still in between ECB meetings, political risks will continue to drive Euro trading in the near term. The advance of the extreme right in Austria is already setting a negative tone for the Euro in early Asian trading.

Later this morning, the deadline set by the Spanish government for the Catalan separatists to clarify their stance will expire, and likely the first steps will be taken to take over the rebellious regional Government later in the week. As if this wasn’t enough, German coalition-building talks should provide yet another set of political headlines to unnerve currency markets. There will also be quite a few speeches by ECB officials, but they are unlikely to provide much new direction and will likely be overshadowed by the political calendar.

USD

News last week was very mixed for the US Dollar. The minutes for the last Federal Reserve meeting showed that some officials are concerned with the absence of inflationary pressures despite the tight labour market.

These concerns received some validation on Friday. The inflation report for September showed an increase in headline inflation to 2.2%, on the back of higher energy costs. However, the more relevant index that excludes volatile food and energy prices remained stuck at 1.7%. This is not quite an undesirably low level, but FOMC members will probably need to see prints of at least 2% in the next few months is our forecast for 2018 hikes is to be correct.