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Sterling extends slide as dollar rallies, gilt yields rise

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By Samuel Indyk

LONDON (Reuters) -The British pound extended its recent drop against the dollar and the euro on Monday driven by investor concerns about Britain’s fiscal sustainability as gilt yields rose for a sixth straight day.

Sterling fell as much as 0.7% against the dollar to $1.21, its lowest level since November 2023. It was last at $1.2124.

Against the euro, the pound was down 0.3% at 84.13 pence.

The pound has been in the crosshairs of global currency traders with British markets hit by surging bond yields, a move which originated from the United States due to concerns about rising inflation and lower chances of rate cuts from the Federal Reserve.

Strong U.S. labour market data released on Friday added momentum to the upward march of global bond yields, with money markets no longer fully pricing in any rate cut from the Fed this year.

While higher yields often support the currency, in Britain analysts expect higher borrowing costs may force the government to rein in spending or raise taxes to meet its fiscal rules, potentially weighing on future growth.

“Clearly something is coming to a head and it’s not because of anything the UK has done over the last two weeks, it’s because of the sensitivity of the UK’s fiscal dynamics to rates and inflation,” said Dominic Bunning, head of G10 FX strategy at Nomura.

“The question for me is if yields start to stabilise, is that enough of a respite that this sell-off starts to slow or takes a bit of a breather?”

Britain’s 10-year gilt yield was up 1.5 basis points on Monday at 4.855%, just below last week’s high of 4.925%, its highest since 2008. It rose over 24 basis points last week, its biggest weekly rise in a year. Bond yields move inversely to prices.

Britain’s 30-year yield rose to its highest level in 27 years on Monday to 5.472%.

British Prime Minister Keir Starmer on Monday said the government would stick to the fiscal rules set out in finance minister Rachel Reeves’ October budget, and that he has full confidence in her. There was little immediate market reaction to his comments.

Reeves gave herself only a small margin of error for meeting her target of balancing spending on public serves with tax revenues by the end of the decade.

The recent rise in borrowing costs and sluggish UK growth data in the second half of 2024 makes reaching that target increasingly difficult.

Attention this week was also likely to be on British inflation data on Wednesday.

Consumer prices are expected to have risen 2.6% annually in December, in line with November, but core CPI is forecast to have moderated to 3.4% from 3.5%.

“This week’s release of the December UK CPI data will be crucial in fine-tuning expectations around the risk of a rate cut next month,” said Rabobank senior FX strategist Jane Foley.

© Reuters. FILE PHOTO: Pound and U.S. dollar banknotes are seen in this illustration taken January 6, 2020. REUTERS/Dado Ruvic/Illustration/File Photo

“Heightened expectations of a February BoE rate cut would likely put the 1.20 level in view.”

Futures markets are pricing in around 16 basis points of easing at the BoE’s February meeting, implying around a 65% chance of a quarter-point rate cut.

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Japanese yen subdued despite BOJ deputy governor’s rate hike hint

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Investing.com– The Japanese yen exhibited minimal movement on Tuesday, despite Bank of Japan (BOJ) Deputy Governor Ryozo Himino indicating a potential hike in the upcoming policy meeting.

Himino suggested that the central bank might consider raising rates, citing sustained wage growth and expectations of a clearer U.S. policy landscape following President-elect Donald Trump’s inaugural address later this month.

The yen’s pair edged 0.1% higher to 157.62 yen on Tuesday.

In recent months, the BOJ has been adjusting its monetary policy to address rising inflation. In March last year, it ended its negative interest rate policy, and by July, it had increased the short-term policy rate to 0.25%.

These measures aim to achieve a stable 2% inflation target, supported by robust wage growth and a weakening yen, which have contributed to higher import costs.

Despite these developments, the yen’s exchange rate against the U.S. dollar remained relatively stable, reflecting market skepticism about the likelihood of an imminent rate hike.

Analysts suggest that while the BOJ is signaling a shift towards policy normalization, uncertainties surrounding global economic conditions and domestic wage dynamics may lead to a cautious approach.

Barclays (LON:) expects the central bank to implement rate hikes in March and October, with a terminal rate of 0.75%.

The BOJ’s next policy meeting is scheduled for January 23-24, where new growth and price projections will be discussed.

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UBS notes hedge funds sell GBP amid UK fiscal worries

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US dollar to stay stronger for longer, UBS says

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Investing.com — UBS strategists expect the US dollar “to stay stronger for longer,” citing robust US economic activity and ongoing tariff concerns impacting other regions.

Monday saw the (DXY) soar to its highest level since November 2022, trading above the 110 mark during the session. This represents a roughly 9% appreciation since late September.

The US dollar’s recent strength has been bolstered by better-than-expected domestic data, including nonfarm payrolls and the services sector purchasing managers’ index. These positive indicators have led to a decrease in the anticipated number of Federal Reserve rate cuts this year, with the consequent rise in US yields lending broad support to the USD.

While US economic data is expected to remain solid in the near term, the outlook for Europe is less optimistic, with subdued growth prospects.

Although growth in China is forecasted to accelerate to 5% year-over-year for the fourth quarter, the threat of US tariffs poses a significant risk. Political and economic uncertainties in South Korea, the European Union, and the UK have been linked to weakness in their respective currencies.

According to UBS, potential monetary policy divergence is among the key factors that could further propel the dollar upward in the near term.

While the Fed is expected to cut rates by a total of 50 basis points in the second and third quarters, the European Central Bank is projected to reduce rates by 100 basis points in the first half of the year.

“Policy divergence is a powerful driver of currencies, which leads to trending FX markets and the potential for overshooting exchange rates,” strategists led by Mark Haefele wrote.

The firm also points out that tariff risks may not be fully accounted for in the current USD valuation. Despite the dollar’s recent rally being largely attributed to solid US macroeconomic data, the introduction of new tariffs could drive the dollar even higher.

UBS suggests that if tariffs are implemented, the DXY could trade between 110 and 115, with significant impacts on other major currency pairs.

“If tariffs were to materialize, DXY could trade in a 110-115 range, could drop below parity, could slide below 1.20, and could move toward 0.94, in our view,” strategists noted. 

However, the investment bank believes that the story of 2025 could be a tale of two halves, with the dollar strength in the first half of the year potentially reversing in the second half.

The current trading position of the USD, which is considered strongly overvalued and shows the highest level of dollar net length since 2015, supports this view.

UBS’s revised forecasts for the EUR/USD pair reflect this expected trajectory. Strategists expect the pair to trade at 1.00 in March, 1.02 in June, and 1.06 in December 2025.

In the case of China, despite the possibility of dramatically higher effective tariff rates, the CNY has only partially priced in this risk, with UBS reiterating its forecast for the to reach 7.50 by June.

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