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The British pound should keep rising against the dollar while stock markets recover, although the same risk appetite eases French fiscal stress and gives the euro an equal lift.
The pound is rising against the dollar as global stock markets recover from last week's AI-led selloff, although the euro is drawing at least as much support from the same improvement in risk appetite.
US stocks rebounded strongly on Monday, with the Nasdaq 100 up 3.4% and the Philadelphia Semiconductor Index up 6.85%, as investors bought back into technology shares.
Brent crude fell to a two-month low of $92.57 a barrel on hopes of a diplomatic end to the US-Iran conflict.
"That combination of tech positivity and oil declines effectively led to the reverse of the stagflation playbook, with investors feeling more positive on growth, and less worried about inflation," says Jim Reid at Deutsche Bank.
The recovery was sharp because investors who had cut their holdings during the selloff had to buy back in, "equity positioning had become sizeably underweight after last week's moves," he adds.
Sterling has tracked the recovery against the dollar: the pound-to-dollar exchange rate rose 0.7% on Monday and trades at 1.3456 on Tuesday.
The pound-to-euro exchange rate is little changed at 1.1974, below the 1.20 level it has failed to close above since late October.
The dollar has lost ground since last week, when it beat every G10 currency as the AI selloff spread, as Pound Sterling Live reported.
Above: GBP/USD at daily intervals.
GBP/USD Needs Stocks to Hold Their Recovery
The dollar loses safe-haven demand when stocks recover, says Commonwealth Bank of Australia.
The pound's gains against the dollar therefore depend on the rebound lasting.
However, "we still believe the AI story is a USD story (AI higher, USD higher and vice versa)," says CIBC, the Canadian investment bank.
CIBC expects the inflow of dip buyers into AI stocks to keep the dollar well supported.
Markets lifted the odds of a December Federal Reserve hike to 84% from 78% on Monday, which Deutsche Bank attributes to easing financial stress.
Higher Fed hike odds support the dollar and limit how far the pound can rise against it.
The pound is also exposed to profit-taking, because investors who have built up bets on sterling sell it to lock in gains when sentiment turns.
Crédit Agricole's positioning model shows those bets have left the pound overbought, and the bank has opened a trade on that signal that profits from a fall in GBP/USD.
US inflation figures for October, due at 13:30 London time on Tuesday, are the next test of Fed hike expectations, with economists expecting consumer prices to rise 0.3% on the month.
The Euro's Recovery Outpaces Sterling
Against the euro, the pound is struggling to make headway because calmer markets ease the French fiscal stress that has weighed on the single currency.
"Sterling traded mixed by gaining against the dollar but losing marginally vs the euro," says KBC, the Belgian bank.
The gap between French and German ten-year borrowing costs, the favoured measure of French stress, narrowed to a three-week low of 147 basis points on Monday.
"The risk-on tone meant the fiscal concerns in Europe eased," says Deutsche Bank's Reid.
Above: The Nasdaq 100 index.
Narrower spreads lift the euro because French fiscal stress has been its main weakness this autumn.
Real-money investors hold their largest short positions in the euro since the start of 2016, says CIBC.
A rising euro forces those investors to buy it back to close their positions, which adds to its gains.
The euro was also cheap going into the rebound, with EUR/USD trading 2.1–2.3% below the level implied by short-term interest rate differentials, says ING.
EUR/USD rose 0.7% on Monday to match the pound's gain against the dollar, leaving GBP/EUR down 0.07% over five days.
Pound Sterling Live Expects GBP/EUR to Consolidate Below 1.20
GBP/EUR has yet to close above 1.20, and Pound Sterling Live's week-ahead forecast expects the pair to consolidate beneath it. The pound gained little from last week's Bank of England rate hike, as Pound Sterling Live reported at the time, saying that the market was fully prepared for the move and was not surprised that the Bank's indicated it stands ready to raise Bank Rate again in the future.
Above: GBP/EUR at daily intervals.
ING estimates EUR/GBP trades 2.6–2.8% below its short-term fair value, and Francesco Pesole, FX Strategist at ING, sees a return to 0.840 (GBP/EUR 1.1905) as "the most realistic move in the coming weeks."
Crédit Agricole's short-term measure of currency valuations, its FAST FX model, lifted its fair value for EUR/GBP to 0.8496 (GBP/EUR 1.1770) from 0.8469 (GBP/EUR 1.1808) on Monday.
George Vessey at Convera, the payments company, advises against buying GBP/EUR above 1.20 given rich valuations and overbought positioning.
UK GDP figures for the third quarter, due on Thursday, are expected to show growth of 0.7%, which would be the fastest pace since the final quarter of 2024.
KBC says a strong reading "should give GBP an edge going into next week's important summit between the UK and EU."
CIBC still looks for EUR/GBP to fall to 0.8316 (GBP/EUR 1.2025).
Pound Sterling Live continues to hold a constructive medium-term view on the pound's prospects; the economy is outperforming, the Bank of England is prepared to tighten further and the euro is undermined by French fiscal stress.
GBP/EUR needs a strong set of GDP figures on Thursday to close above 1.20 and extend its rally.
