Sterling today: Pound firms as dollar retreats from Friday rally

The dollar's recent rally, which saw it strengthen significantly, is now experiencing a notable retreat. This appreciation was initially spurred by a tech-led equity market rout, which drove investors towards safer assets, and a U.S. jobs report that surpassed expectations, indicating underlying economic strength. However, analysts suggest this rally might have been overextended relative to immediate market drivers, leading to the current correction as the initial risk-off mood subsides.

Dollar's Retreat

Francesco Pesole, an FX strategist at ING, highlighted that the dollar's appreciation was likely a delayed reaction to the contagion into defensive stocks and global markets. He posits that for the dollar rally to persist, a sustained risk-off mood is necessary. Without it, there is a moderate correction risk, as Friday's upward movement appeared somewhat stretched compared to short-term market fundamentals. The U.S. payrolls report, which showed a rise of 165,000, beat expectations and contributed to market pricing of a 19 basis point Federal Reserve hike in December, reflecting a hawkish stance.

Upcoming economic data, specifically the October consumer price data due on Tuesday, is anticipated to show 0.3% month-on-month growth for both headline and core inflation, aligning with consensus forecasts. This data is expected to reinforce market expectations for a December Fed rate hike, potentially providing some support for the dollar. However, the current sentiment suggests that the dollar index may not revisit its previous low of 101.1 unless new instability emerges in risk sentiment, a hotter-than-expected CPI print occurs, or a hawkish European Central Bank appointment is made.

Bank of England

Last week, the Bank of England (BoE) implemented a rate hike, a move that has been closely watched by currency markets. Governor Andrew Bailey is scheduled to speak, and his comments are expected to provide further clarity on the central bank's future monetary policy direction. The lack of dovish dissenters during the recent rate decision reinforced ING's view that another hike could occur in February, although building consensus for such a move might prove challenging among committee members.

Some members of the Monetary Policy Committee are reportedly considering a "one-and-done approach" to rate increases, suggesting a cautious stance on further tightening. HSBC noted that Huw Pill, another MPC member, indicated that rates could potentially fall if economic growth slows next year. Governor Bailey himself has signaled caution regarding additional rate hikes, implying a reluctance to raise rates more than once again. This nuanced outlook from the BoE creates uncertainty around sterling's trajectory, particularly against the euro.

Francesco Pesole

Francesco Pesole, a key FX strategist at ING, provides critical insights into the current currency valuations and future expectations. He views sterling as currently expensive against the euro, noting that EUR/GBP, trading around 0.834, is approximately 2.6-2.8% below ING's short-term fair value. This assessment suggests a potential for the euro to strengthen relative to the pound in the near term. Pesole also estimates that the drop in EUR/USD appears too sharp compared to its short-term rate differential, indicating an undervaluation of the euro against the dollar by about 2.1-2.3%.

Looking ahead, ING, through Pesole's analysis, anticipates that EUR/USD could return above 1.120, provided that risk sentiment does not face new instability this week. Furthermore, a return to 0.840 in EUR/GBP is considered the most realistic movement in the coming weeks, reflecting the expected correction in sterling's valuation. These projections underscore the importance of macroeconomic data and central bank rhetoric in shaping currency movements, with Pesole's analysis offering a detailed roadmap for potential shifts in major currency pairs.