The Federal Reserve (Fed) restarted its interest rate cutting cycle last month...
...cutting rates by 25 basis points, as expected. Short-term interest rates remain a key focus, and from here the path in the US is uncertain. Risks to the labour market and inflation are conflicting for the Fed - in that the labour market is weakening but inflation remains above target, with the threat of tariffs lifting it further. This conflict is reflected in the differing views of US monetary policymakers – but the median member concurs with the market expectation of two further cuts this year. The dollar weakened as we approached last month’s decision, sending EURUSD to a fresh four-year high of 1.1919. However, since then the USD has recovered modestly, in part thanks to some profit-taking by USD short sellers as markets recalibrate their outlooks. Was that the peak for EURUSD this year then, or is there further to go? Our economists’ forecast sees us touching 1.2000 before year-end.
A large cloud now hangs over the dollar’s future
On the one hand, there are certainly arguments for continued USD weakness. The Fed has restarted cutting rates while the Bank of Japan may resume raising them, and EU fiscal spending is likely to come to fruition soon, all of which lends to further USD aversion in a still uncertain US policy environment, and a US government shutdown as I type. Yet on the other hand, US GDP growth has been a little better than expected and the policies enacted by Trump recently have not triggered large negative reactions in markets. Could US productivity growth and private investment still exceed its global peers’, and the USD then resurge once the fear factor subsides? Who knows. On a positive note, global growth forecasts have held up despite the trade war worries earlier in the year. That is in part due to global trade flows continuing, with Chinese exports finding new destinations, as per Chart 1 which I have shamelessly pinched from our excellent economists.
Chart 1: Chinese exports find new destinations in response to US tariffs
Notes: Data as of August 2025
Sources: Macrobond, Investec.
Sterling’s fiscal concerns remain
Sterling upside remains capped by Budget worries
Inflation stickiness in the UK has prompted our economists to push back their expectations of further Bank of England interest rate cuts – they now don’t expect another cut until February. Markets too have scaled back UK rate cut bets, yet even while focus is firmly on short-term interest rates elsewhere, the pound hasn’t found much relief. That, I think can be attributed to the fairly asymmetrical risks around the Autumn Budget – it’s unlikely Chancellor Rachel Reeves pulls a rabbit out of the hat on Budget day that triggers huge sterling-buying. But I’m sure I don’t need to tell you how it can go wrong, à la 2022. Political discourse elsewhere has subsided slightly though, such as in France, which our economists don’t foresee weighing on the euro. GBPEUR now trades in the 1.1400s again, approaching two-year lows.
Meanwhile down under, a divergence is emerging in Australasia
The AUD and NZD aren’t tied to each other, of course, but it’s fair to say you’d expect AUDNZD to move a little less than other pairs, and especially so when the market has tunnel vision for the USD. Yet, the AUD has gained 7.00% versus the NZD in just five months, which is a story of economic and central bank divergence. The Reserve Bank of New Zealand is expected to continue reducing interest rates while its Australian counterpart is drawing close to concluding its cutting cycle. In economic growth terms, the Aussie economy expanded by 0.6% in Q2, while the Kiwi economy contracted by 0.9%, which is quite the difference. Versus sterling, the move has seen GBPAUD fall to a six-month low, while GBPNZD flirts with its ten-year (and post-Brexit) high.
Chart 2: Economic divergence causes AUDNZD to spike
Sources: Bloomberg, Macrobond, Investec
Forecasts
Sources: Macrobond, Bloomberg, Investec
GBP/USD
Sources: Macrobond, Bloomberg, Investec
GBP/EUR
Sources: Macrobond, Bloomberg, Investec
Notes: Forecasts are produced by Investec Economics and are for end-quarter
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Ria Selvaratnam
Head of Treasury Sales
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