The GBP/USD exchange rate dived to its lowest level since May 2024 as the US dollar index surge gained steam. It dropped to a low of 1.2497, much lower than the year-to-date high of 1.3430 after the latest Federal Reserve and Bank of England (BoE) interest rate decisions. 

Bank of England interest rate decision

The GBP/USD exchange rate continued falling as the Bank of England delivered a relatively dovish statement on Thursday.

The bank decided to leave interest rates unchanged at 4.75% as it remained concerned about the elevated inflation rate in the country.

Unlike the Fed and the European Central Bank, the BoE has already embraced a more gradual pace to interest rate cuts. It has slashed rates by just 0.50% this year, while the two other banks have cut by about 1%.

Still, there are signs that a more dovish tilt is emerging from the BoE as 3 officials voted to cut rates by 0.25%.

The BoE decision came a day after a report by the Office of National Statistics (ONS) showed that the headline Consumer Price Index (CPI) rose from 2.3% in October to 2.6% in November. Core inflation moved from 3.3% to 3.5%, still higher than the bank’s target of 2.0%.

The Retail Price Index (RPI) rose from 3.4% to 3.6%, while the harmonized inflation rate moved to 3.5%. These numbers meant that the country’s inflation remains stubbornly high and that the bank has room to leave rates unchanged for long.

UK is in a stagflation

The challenge, however, is that the UK is going through a stagflation process. Stagflation is a situation where a country goes through high inflation and slow economic growth. In theory, it is one of the most difficult situations to manage since cutting rates will lead to more growth, but cause inflation. High interest rates, on the other hand, hurt a country’s growth by limiting the economic growth.

Therefore, the GBP/USD pair crashed because analysts expect that the bank will be more dovish in the coming year. Most analysts expect it to cut rates by 55 basis points, while those at ING estimate that it will cut by 150 basis points. In a note, they said:

“The apparent growing dovish front within the MPC in spite of the latest hawkish wage data potentially suggests a greater focus on slowing activity. That reinforces our dovish view on the Bank of England for next year – we expect 150bp of cuts, against market expectations for around 55bp.”

The GBP/USD pair crashed also because of the hawkish Federal Reserve. In a statement, the Fed hinted that they will deliver two rate cuts in 2025, lower than the previous estimation of four. That hawkish tone pushed the US dollar index to the highest level in over two years.

GBP/USD technical analysis

GBP/USD chart by TradingView

The GBP/USD exchange rate has been in a strong downward trend in the past few months. It has recently formed a death cross pattern as the 50-day and 200-day moving averages crossed each other. 

The pair has also moved below the lower side of the ascending channel. Also, it has moved to the support at 1.2497, its lowest point in November. Therefore, the path of the least resistance for the pair is bearish, with the next point to watch being at 1.2300, the lowest point in April this year. 

The only short-term hope for the pair is that it has formed a small double-bottom pattern at 1.2497 and whose neckline is at 1.2800. That is a sign that it will bounce back soon.

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The Brazilian real showed signs of recovery on Friday, rising over 6.1 per US dollar after falling to a record low of 6.29 on December 18.

This comeback is primarily due to strong interventions by the Central Bank of Brazil (BCB), which has sought to support the currency amid continued budgetary uncertainty.

The BCB’s commitment to improving market liquidity reflects a determined effort to relieve real-world pressures and restore investor confidence.

Massive liquidity injection by the central bank

In a decisive move, the BCB injected roughly $27.75 billion into the market over the last week, primarily through spot auctions and line operations involving repurchase agreements.

By injecting significant dollar liquidity, the central bank not only relieved some of the immediate pressures on the real but also attempted to stabilize foreign currency rates. This aggressive effort has instilled hope into the market, helping the real to recoup some of its losses.

The central bank’s operations represent a purposeful response to increased volatility and market worry over Brazil’s economic dynamics.

Such efforts are critical to restoring market confidence and establishing a more stable trading environment, and they appear to have helped the currency’s recent strength.

Legislative progress lifts market sentiment

Market sentiment has also improved in response to the Brazilian government’s legislative efforts. According to reports, progress has been made on the fiscal package that is presently being considered by Congress.

Notably, the Senate has authorized a series of budget cuts intended to improve Brazil’s fiscal prospects. Furthermore, recent initiatives have tried to reduce the qualifying criteria for different income distribution programs that provide financial benefits to residents, as well as impose spending limits on public employees.

These initiatives reflect Brazil’s urgent need for fiscal consolidation and demonstrate the government’s commitment to implementing deficit-reduction measures.

Investors have reacted positively to these developments, seeing them as important and opportune initiatives to strengthen the country’s financial stability.

Lingering challenges cloud long-term outlook

Despite the recent rebound in the real economy and the early comfort provided by the government’s fiscal measures, the long-term prognosis remains uncertain.

Analysts warn that, while immediate pressures may have subsided, substantial difficulties remain that might stymie sustained fiscal consolidation.

One of the most significant obstacles is the government’s ability to maintain a cohesive and successful fiscal strategy in a politically sensitive atmosphere.

The fiscal package’s effectiveness will be determined not only by its immediate effects but also by the government’s ability to execute and enforce these policies against opposition from various political factions and interest groups.

Furthermore, broader economic issues such as commodity price variations, global economic trends, and potential external shocks may hinder Brazil’s recovery.

The real remains subject to fluctuations in investor sentiment, which can be influenced by developments in Brazil as well as the global economic situation.

A delicate recovery

The Brazilian real’s comeback above 6.1 per USD marks a watershed moment for the country’s economy, aided by significant central bank policies and legislative efforts to address budgetary issues.

However, as Brazil navigates these tumultuous waters, the path to long-term recovery remains complex and uncertain.

As the BCB continues to monitor the situation and respond to market dynamics, investors will be looking for additional indications about the government’s fiscal strategies and their potential impact on general economic stability.

The following months will be critical in evaluating whether the current recovery is a sign of long-term improvement or only a brief respite in a difficult budgetary situation.

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Donald Trump, the president-elect of the United States, has issued another warning to the European Union, threatening tariffs if its member states do not increase their purchase of American oil and gas.

The statement, made via Truth Social, signals Trump’s intent to leverage energy exports to address the US-EU trade deficit, a long-standing grievance.

With the US being the world’s largest producer of crude oil and a top exporter of liquefied natural gas (LNG), the threat places significant pressure on the EU to act.

Trump’s hardline stance comes just over a month before his inauguration, during a high-profile visit to Paris for the reopening of the Notre Dame Cathedral, where trade tensions were a key topic of discussion.

EU braces for new US trade measures

European officials, recalling the tumultuous trade policies of Trump’s previous administration, have been preparing for renewed tensions.

In 2017, Trump imposed tariffs on European steel and aluminum, citing national security concerns, catching the bloc by surprise.

Since then, the EU has overhauled its trade doctrine, implementing robust mechanisms to counter coercive practices.

The EU’s recently adopted anti-coercion instrument empowers the European Commission to impose retaliatory tariffs or other punitive measures in response to politically motivated trade restrictions.

This tool is part of a broader strategy to protect the bloc’s interests under challenging trade dynamics.

The foreign subsidies regulation allows the commission to block foreign companies benefiting from unfair state support from participating in public tenders or mergers within the EU.

German Foreign Minister Annalena Baerbock addressed these preparations during a Group of Seven meeting in Italy last month.

She emphasized that Europe is ready to respond decisively if Trump pursues an “America First” approach, reinforcing the bloc’s commitment to unity in the face of external pressure.

US is a major energy supplier to Europe

The US remains a vital energy supplier to Europe, with American LNG accounting for over half of the EU’s gas imports last year.

These imports have been pivotal in reducing the bloc’s reliance on Russian energy following the Ukraine conflict.

However, Trump’s demands for increased purchases highlight the underlying tensions in transatlantic trade relations.

The US has also emerged as a major crude oil exporter, supplying markets across Europe and Asia.

Trump’s rhetoric underscores his administration’s focus on leveraging energy exports as a tool to address trade imbalances.

While Europe is a key destination for American oil and gas, Trump’s tariff threats add a layer of complexity to an already delicate trade partnership.

Trump’s grievances extend beyond energy. He has criticized Europe for insufficient defense spending and the persistent trade deficit with the US.

His approach, which he described as “tough love” during his previous term, signals a likely continuation of confrontational trade policies.

Is Trump serious about this?

The EU faces a critical challenge in navigating its relationship with the incoming US administration.

Trump’s rhetoric, coupled with his past actions, suggests that trade disputes could escalate rapidly if Europe fails to meet his demands.

The bloc’s enhanced trade defenses and unified stance offer some reassurance, but the potential for conflict remains high.

Europe’s response will likely focus on balancing economic interests with geopolitical realities.

As the largest consumer of US LNG, the EU holds significant leverage, but Trump’s readiness to impose tariffs underscores the risks of over-reliance on a single energy partner.

The coming months will reveal whether Trump’s hardline tactics will lead to a deeper transatlantic rift or a renegotiated trade dynamic that benefits both sides.

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The latest economic data reveals a welcome moderation in inflation, as the personal consumption expenditures (PCE) price index rose by a less-than-expected 0.1% in November.

This figure, a notable decrease from October’s unrevised 0.2% gain, coupled with solid but somewhat disappointing consumer spending, has provided some relief to markets that have been grappling with the Federal Reserve’s recent “hawkish” rate cut.

This report presents a complex picture for policymakers and investors alike, as they balance the need to control inflation with concerns about economic growth.

Inflation eases, but remains above target

The Commerce Department’s report on Friday also showed that the PCE price index increased by 2.4% in the year through November, up from 2.3% in October.

This slight rise in the annual inflation rate is partially attributed to lower readings from last year dropping out of the calculation.

Excluding the volatile food and energy components, the PCE price index climbed by 0.1%, a decrease from October’s unrevised 0.3% gain.

In the 12 months through November, core inflation increased by 2.8%, matching October’s figure.

This mixed set of data highlights that while price pressures are easing, inflation remains above the Fed’s 2% target.

Market reaction

According to a Reuters report, the market’s response to the inflation data was notable, as the S&P 500 pared some of its earlier losses, closing down -0.51%, while US Treasury 10-year yields fell to 4.506%, and the two-year yield declined to 4.259%.

The dollar index also showed a loss of 0.42%.

As Adam Sarhan, chief executive of 50 Park Investments, noted, “The market is having a little bit of a relief rally here… The Fed came out on Wednesday and said inflation is still public enemy No. 1. They cut rates but… inflation was still not where they wanted it to be.”

Sarhan also states that “So, it’s a bullish reaction from the major indices’ standpoint… because the data takes away the threat that inflation is out of control… Today’s data doesn’t force the Fed’s hand. It’s not hot enough where the Fed has to raise rates, and hence the relief rally. And we’re really oversold in the short term.”

Chris Zaccarelli, chief investment officer at Northlight Asset Management, told Reuters that “The market woke up in a terrible mood – an unexpected government shutdown and a more-hawkish-than-expected Fed are to blame – but this morning’s inflation data came in lower-than-expected and took some of the edge off.”

However, he also points out that “We expect the market will continue to sell off into the weekend, but we will be watching the last 15 minutes of trading today to see how we finish. If the selling builds throughout the day and there is momentum (to the downside) heading into the weekend then that would be a bad sign for next week, however, if we see some dip-buying later today and the market finishes significantly higher than the lows of the day would suggest, then that would make us more optimistic for next week.”

The market’s response seems to reflect a battle between short-term relief and lingering doubts about the Federal Reserve’s future actions.

The Fed’s balancing act

Brian Jacobsen, chief economist at Annex Wealth Management, told Reuters that, “Powell must be getting tired of the data undermining things he says. Lower inflation than expected and slower spending growth don’t corroborate the Fed’s sudden tilt towards hawkishness. The jump in auto sales isn’t likely going to be a massive driver of growth over the next year. Consumers aren’t shelling out more on everyday spending items. The Fed will likely change its tune once again sometime soon.”

The conflicting economic signals present a challenge for the Fed, further emphasizing the complexity of navigating economic policy amidst uncertain market conditions.

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