August inflation data out of the US did nothing to allay fears that the Fed's inflation target is still out of reach, triggering investors to price in a near certainty of a hike this week.
There is still significant uncertainty, of course, as Fed officials cannot make pronouncements on monetary policy this close to the meeting, while Chair Warsh has severely cut back the Fed’s guidance to markets. We now expect a hike, however, and with futures pricing in a 90% chance of a 25 basis point move, failure to follow through would send shockwaves through markets and probably add fuel to the sell-off in long-term rates. Whether the FOMC validates aggressive markets bets for rate increases beyond then remains an open question.
The dollar rallied on Friday’s inflation beat, but the moves were modest. Long-term rates continued their relentless rise and hit fresh multi-decade highs, equities retreated but continued to hold up surprisingly well, and oil soared past $100 on fresh negative news flow from the Iran conflict. The Fed's September meeting will dominate trading on Wednesday, though two other key central bank meetings will take place within a 24 hour period this week. The Bank of England looks set to hold on Thursday, and the recent rally in the yen will need to be validated by a hike from the Bank of Japan on Friday. All in all, a critical week for currency markets generally.
GBP
A robust monthly GDP report for July confirmed the broadly strong tone of recent economic news out of Britain, which remains remarkably resilient despite prevailing downside risks. The UK economy expanded by 0.4%, in part it seems due to the impact of AI spending - well above the zero growth consensus. Gilt markets, meanwhile, stabilised last week following some reassuring rhetoric from Chancellor Healey, who once again voiced a commitment to the fiscal rules. The sell off in government bonds has been a global problem, so sterling has not suffered particularly as a result of the relentless rise in gilt yields.
This week is unusually packed. The monthly labour market data on Tuesday will be followed by the inflation report for August on Wednesday. Both data points will be available to MPC members prior to their rate decision on Thursday, but neither should change the decision to keep rates unchanged. The key for the pound will be the number of hawkish dissenters as well as the forward guidance offered by the bank. We do not think that the MPC will be pressured into raising rates at all this year, so any hawkish pivot in the bank’s remarks this week would be a surprise to us.
EUR
Last week’s September meeting of the European Central Bank delivered the expected hike and hawkish communications from the bank. Lagarde said that the risk of inflation staying higher next year had increased, while she also dismissed the importance of the neutral level of rates, which we think lowers the bar for additional policy tightening. The usual leak from ECB ‘sources’ following the press conference even left the door open to a highly unusual back-to-back rate increase at the next meeting in October, with markets now expecting three additional hikes and a terminal rate of 3.25%.
The common currency failed to benefit from this hawkishness as rates in the US are undergoing a similar upwards repricing, leaving the gap essentially unchanged. Beyond monetary policy, economic data flow continues to surprise on the upside, validating both the ECB's hawkish stance and our generally positive view of the euro. Aside from revised inflation figures out on Thursday, there will be little economic news released from the Euro Area this week, so expect the euro to take its cue almost entirely from Wednesday’s Fed meeting.
USD
The Federal Reserve decision this week stood on a knife's edge prior to Friday’s CPI data, though the report itself appears to have almost certainly settled the issue. Core inflation rose 0.3% for the month, an annualised rate of around 3.5%, a sign that spillover effects from the energy price spike remain. Diesel prices above $6 a gallon are driving media headlines, the labour market remains strong, and rising oil prices mean no immediate relief is in sight.
While we contend that the data itself is not necessarily screaming out for tighter policy, the Fed risks losing whatever credibility it has left unless Chair Warsh defies pressure from President Trump and delivers a rate increase on Wednesday. We think that the decision itself will be a closer call than markets are making out, however, and don’t be surprised to see a handful of dissenters in favour of a hold, only a modestly revised dot plot and rhetoric that far from fully endorses the aggressive tightening cycle currently priced in by futures markets.
Deep dives and expert insights:
- G10 currency market report - Get the latest analysis on major currencies.
- FOMC September Meeting Preview
- ECB September Meeting Reaction
- FX Monthly - September 2026
- G3 FX Outlook - September 2026
