The Dollar Gains Ground as Rate Expectations Shift

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Last week was a significant one for the FX market, with allthree major currencies facing fresh pressure from higher energy prices andchanging interest-rate expectations.

The Federal Reserve raised rates for the first time since2023, while the Bank of England held rates but left the door open to furtherincreases as UK inflation remains elevated. The euro is also facing renewedinflationary pressure, particularly from higher energy costs.

With no major central-bank decisions this week, attentionnow turns to economic activity, oil prices and the latest business surveys.

🇬🇧 GBP | Sterling

The Bank of England keeps the door open

Sterling faced a difficult week after UK inflation rose to 3.1%in August, adding to concerns that higher energy and fuel costs could keepinflation elevated.

The Bank of England subsequently left interest ratesunchanged, but the vote was closer than expected, with three policymakersbacking a rate increase. The Bank also warned that the energy shock couldpush inflation higher in the months ahead.

This has given sterling some support, although the pound hasstruggled against the dollar as US interest-rate expectations have movedhigher.

This week: Markets will be watching UK businessactivity data, including the preliminary manufacturing and services PMIs,alongside public-sector borrowing figures.

Our view: The Bank's increasingly cautious approachtowards inflation provides some support for GBP, but higher energy costs andthe stronger dollar remain important headwinds.

🇪🇺 EUR | Euro

Energy prices remain the key risk

The euro continues to face a difficult combination of higherinflation and concerns over economic growth.

The ECB's recent rate increase demonstrated its willingnessto respond to renewed inflationary pressure, but higher energy prices couldmake the policy outlook increasingly difficult. Pound Sterling Live notes thatrising gas prices and expectations of further US rate increases are limitingthe euro's ability to build momentum against the dollar.

This week: The preliminary Eurozone and German PMIswill provide an early indication of how businesses are responding to higherenergy costs. German IFO business confidence is also due later in the week.

Our view: The euro remains caught betweeninflationary pressure, which supports higher rates, and weaker growth, whichargues for caution from the ECB.

🇺🇸 USD | USDollar

The Fed changes the interest-rate picture

The dollar was the strongest of the major currencies lastweek following the Federal Reserve's first rate increase since 2023.

The decision, combined with a more hawkish outlook from theFed, pushed US rate expectations higher and provided renewed support for thedollar. FXStreet reported that the US Dollar Index reached a fresh seven-weekhigh as markets began pricing in the possibility of further rate increases.

Higher oil prices are also supporting the dollar by keepinginflation concerns firmly in focus.

This week: The preliminary US manufacturing andservices PMIs are the main economic releases to watch. Markets will also bemonitoring US employment data, oil inventories and developments from theTrump-Xi meeting.

Our view: USD enters the week with strong momentum,although the market will now be looking for evidence that the US economy cancontinue to outperform while rates remain elevated.

The Week Ahead

With the major central-bank decisions now behind us, thefocus shifts towards economic growth and energy prices.

Monday: UK industrial orders and US economic data

Tuesday: US employment data and Eurozone consumerconfidence

Wednesday: UK, Eurozone and US preliminary PMIs

Thursday: German business confidence, US data andcentral-bank commentary

Throughout the week: Oil prices, bond yields anddevelopments surrounding the Middle East and US-China trade relations.

The Bottom Line

Last week changed the interest-rate outlook across the majorcurrencies.

The Fed has moved towards tighter policy, the Bank ofEngland remains concerned about inflation, and the ECB continues to deal withthe impact of higher energy costs.

This week is likely to be more focused on economic datarather than central-bank decisions, with the PMI releases providing animportant snapshot of whether higher energy costs are beginning to weigh onbusiness activity.

For businesses with upcoming international payments, the keyfactor to watch remains the relationship between inflation, interest ratesand economic growth.

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