Weekly FX Outlook: Sterling’s Fragility, ECB’s Hawkish Hold, and the Fed’s Cut

The foreign exchange market has been anything but quiet this week. Sterling showed strain against the euro despite better-than-expected UK retail sales, while the dollar slipped on the back of the Federal Reserve’s rate cut. The euro, meanwhile, is holding firm thanks to the European Central Bank’s hawkish tone, even as French politics add some background noise.

As we push past the mid point of September, the big question for traders and corporates is clear: are we in the calm before the storm?

Sterling’s performance has been a split story. Against the dollar, the pound has stayed resilient, helped by Fed dovishness. Against the euro, the picture looks more fragile.

UK retail sales surprised to the upside this week, yet sterling still slipped. That tells us something important: markets are reluctant to reward the pound even when data beats. Traders remain more comfortable selling rallies than chasing upside momentum.

A major weight on sentiment is the UK’s fiscal position. August’s borrowing figures shocked the market, showing the deficit running far ahead of expectations. Spending rose faster than tax receipts, and debt servicing costs climbed, leaving Chancellor Reeves with a tough hand ahead of November’s budget.

For FX markets, the worry is simple: can the government convince investors it has the discipline to keep debt sustainable? If gilt markets lose confidence, the pound is often first to feel the strain.

The BoE held rates at 4% this week and slowed the pace of quantitative tightening. On the surface, that looks cautious, but the message was clear: inflation is expected to ease further, and cuts are still on the table.

Governor Bailey stressed that easing will come “gradually and carefully.” Whether the next step lands in November or December, the direction is downward. Markets have leaned into that view, and sterling is paying the price.

Looking forward, three events stand out:

The pound and euro have been locked in a tightening wedge since July. Think of it as a coiled spring: each bounce is smaller, the range is narrowing, and the energy is building. When it breaks, the move is rarely gentle.

GBP/EUR the pair is pressing the lower edge of the range. If next week’s UK PMIs and Bailey’s tone disappoint, the pair could snap lower. For recent currency market analysis covering similar themes, see our latest weekly currency outlook. Stronger data or a firmer BoE stance could instead spark a rebound toward 1.1580 and possibly the summer highs above 1.16.

The European Central Bank delivered what markets expected: a hold on interest rates. But the tone was anything but neutral. Growth forecasts were upgraded, inflation is expected to hover near target, and President Lagarde declared the disinflation phase over.

For investors, this was a hawkish hold, one that gives the euro a clear floor when compared with a cutting Fed.

Meanwhile, French politics have added some noise. Fitch downgraded France’s credit rating, and Bayrou resigned after losing a confidence vote. Yet markets are treating it as a contained story, not a eurozone-wide crisis. French spreads widened only modestly, and there’s no sign of systemic stress.

Next week brings a critical set of releases:

Narrative: Political headlines may grab attention, but until they translate into systemic risk, fundamentals dominate. If data holds up, EUR/USD looks set to grind toward 1.18.

The Federal Reserve delivered the expected cut this week, confirming what markets had already priced in. Even so, the confirmation was enough to nudge the dollar lower. Importantly, the Fed signalled more cuts are coming, with October and December in play. For recent analysis of Fed policy and GBP performance, see our latest weekly FX outlook.

The bigger story was the jobs market. August payrolls badly missed, and downward revisions showed the labour market weaker than thought. Unemployment ticked higher, giving the Fed its green light to start easing.

The Fed’s preferred inflation gauge, the PCE index, lands on Sept 26. A softer print would cement expectations for deeper cuts. A firmer one would force the Fed to move slower, keeping some support under the dollar.

Narrative: Divergence is the driver. The Fed is easing, while the ECB and BoE are holding. That’s enough to keep the dollar pressured into year-end, though safe-haven demand keeps it from collapsing.

The last two weeks of September bring PMIs, inflation data, and central bank speeches. These are the catalysts that can break ranges and trigger sharp moves. For corporates with exposure, this is not the time to assume stability. Locking in rates, reviewing hedge strategies, and preparing for volatility should be front of mind. For strategies to protect against currency volatility, see our comprehensive forward contracts guide.

Bottom line: Sterling is fragile against a well supported the euro, and the dollar is under pressure. With multiple catalysts lined up before month-end, volatility is likely.