FX Outlook: Why Markets Are Starting to Worry About Growth Again

For most of the year, markets have been focused almost entirely on inflation and interest rates. The assumption was simple enough: central banks keep rates higher for longer, yields stay elevated, and currencies linked to those higher yields remain supported. 

Now, investors are starting to ask a slightly different question. 

What happens if growth begins slowing faster than expected? 

That shift in thinking became more visible this week after weaker UK PMI data triggered a modest pullback in Sterling. The UK services sector unexpectedly slipped into contraction territory, suggesting businesses are becoming increasingly cautious amid rising costs, political uncertainty and weaker demand. 

GBP/USD drifted lower after the release, while GBP/EUR also softened initially before stabilising fairly quickly. That second part matters. 

The reason downside in GBP/EUR remained relatively limited is because the Eurozone is hardly in brilliant shape either. 

Eurozone PMI data released shortly before the UK numbers also disappointed. Germany’s industrial backdrop remains fragile, consumer confidence across parts of Europe is still subdued, and investors continue questioning how much genuine growth momentum the region actually has underneath the surface. 

In other words, the pound is slowing, but the euro is not exactly sprinting ahead either. 

That increasingly explains why GBP/EUR has spent much of recent months trading in relatively controlled ranges despite ongoing economic concerns on both sides. 

On one hand, weaker growth data normally increases expectations for future Bank of England rate cuts, which would usually hurt the pound. 

On the other hand, inflation pressures have not disappeared. 

Energy prices remain elevated. Supply chain pressures are quietly rebuilding again in some sectors. Wage growth is still relatively sticky. Businesses continue reporting rising input costs. Politics is also starting to outweigh the data in certain areas of the market. 

That leaves the Bank of England in an awkward position. 

Cut rates too quickly and inflation risks returning more aggressively. Keep rates elevated for too long and growth slows further. 

Not exactly the sort of balance central bankers enjoy explaining at press conferences. 

For now though, markets still believe UK rates are likely to remain relatively high compared to the Eurozone. That yield advantage continues offering Sterling some underlying support, particularly against the euro. 

The dollar continues benefiting from something very simple: investors still trust the US economy more than most alternatives. 

Even with growing expectations for eventual Federal Reserve cuts later this year, the US still offers: 

That combination remains powerful and it is one of the reasons GBP/USD rallies continue struggling to gain completely clean momentum, despite periods of softer US inflation data.
There is also a broader structural story developing underneath the surface.
Investors are increasingly rewarding economies seen as more productive, more innovative, and better positioned for long-term capital inflows. Artificial intelligence investment, technology spending and productivity growth are all becoming more relevant to FX markets than they were even 18 months ago.
The US continues leading there.
 
The UK, interestingly, is beginning to attract more attention in that conversation as well, particularly compared to parts of Europe where growth remains heavily constrained by industrial weakness and energy sensitivity.
That does not suddenly make Sterling a one-way trade higher.
Far from it.
 
The UK still faces significant fiscal pressures, soft consumer demand and ongoing political uncertainty heading into the second half of the year. Markets are simply becoming more selective about where they see sustainable growth and credible central bank policy.
At the moment:
 

From a practical client perspective, this means volatility is unlikely to disappear anytime soon.
Markets are no longer reacting solely to inflation numbers. Investors are now trying to work out which economy slows first, which central bank blinks first, and which currencies still offer enough yield to justify holding them through the uncertainty.
That tends to create choppier trading conditions rather than clear long-term trends.
 
The next few weeks will likely revolve around:
 

As always in FX markets, expectations matter just as much as reality.
 
Sometimes more.
And right now, markets feel slightly less convinced about the global growth story than they did a few months ago.
Which, admittedly, is not ideal timing for anyone trying to budget international payments while also pretending to enjoy reading PMI surveys over their morning coffee.