🇬🇧 Sterling Gains as Stagflation Concerns Linger
Sterling had a positive week, with GBP/USD rising around 0.5% on Monday morning and briefly testing 1.35, despite the UK bank holiday. GBP/EUR also moved higher, pushing towards 1.16. However, the rally came despite weaker UK data. May’s services PMI fell sharply from 52.7 to 47.9, below expectations of 51.7, while the composite PMI dropped from 52.6 to 48.5.
As readings below 50 signal contraction, the figures point to a loss of economic momentum. The bigger concern remains stagflation with slowing growth alongside persistent cost pressures becoming a key theme of the economy. Businesses reported weaker output, supply shortages, job cuts and rising input costs, partly driven by fuel and raw material pressures.
This leaves the Bank of England in a difficult position. Keeping rates high could weigh further on growth, while cutting too soon could risk sticky inflation and reduce support for sterling. Markets will be watching closely to see how the BoE balances these risks, especially with Middle East tensions adding further uncertainty to energy and input costs.
🇺🇸 Markets Eye US-Iran Talks as Dollar Holds Firm
Key investment banks continue to see scope for USD to regain resilience, even against a backdrop of geopolitical uncertainty. The Dollar is being supported by a combination of sticky inflation, a less dovish Federal Reserve, US energy independence and strong AI-related investment.
The US economy still has enough underlying strength and inflation pressure to prevent the Dollar from falling too far. Geopolitics also remains a major driver for markets.
Oil prices have fallen sharply and Asian equities have risen on hopes that progress in US-Iran talks could ease tensions. US Secretary of State Marco Rubio said negotiators had a ‘pretty solid thing on the table’ and suggested an agreement could be reached soon. However, Iran has pushed back, saying that while some progress has been made, a deal is ‘not imminent’.
As long as negotiations remain unresolved, the Dollar is likely to retain support from its safe-haven status. Any signs of a breakthrough could reduce that demand, but delays or renewed escalation would likely keep investors cautious and continue to underpin the Dollar.
🇪🇺 Eurozone Momentum Fades as PMI Data Disappoints
Last week’s Eurozone PMI data pointed to an economy rapidly losing momentum, adding further pressure to the Euro’s outlook. The Eurozone Composite PMI fell to 47.5 in May from 48.8 in April, missing expectations and remaining firmly below the 50 threshold that signals contraction. The weakness was largely driven by the services sector, where the services PMI dropped from 47.6 to 46.4, marking a 63-month low.
This suggests business confidence is deteriorating as activity slows across the bloc. Markets interpreted the data as evidence that the Eurozone economy is coming under increasing strain from geopolitical tensions in the Middle East, the lingering impact of US tariffs and intensifying cost pressures.
However, the softer labour market backdrop may reassure some members of the ECB’s Governing Council that the risk of second-round inflation effects remains limited. As a result, the data reduces the pressure on the ECB to hike rates further, particularly if growth continues to weaken..
🇦🇺 Currency In Focus – Australian dollar
This week’s currency in focus is the Australian dollar, which has delivered a strong start to 2026.
TD Securities noted that AUD’s year to-date rally is comparable to some of its best starts over the past 15 years. However, the concern now is that much of the positive news may already be priced in. Investor positioning is heavily long AUD, meaning many traders are already betting on further gains. When positioning becomes stretched, the currency becomes more vulnerable to a pullback. The main catalyst for AUD strength has been the Reserve Bank of Australia, which has raised rates three times this year, taking the cash rate to 4.35%. This has made the Australian dollar attractive to global investors from a yield perspective.
However, major investment banks now believe this rate advantage may be starting to fade. Rising global bond yields mean other central banks could begin catching up, reducing Australia’s relative yield appeal. There is also a China-related risk. China is Australia’s largest export destination and a major buyer of industrial raw materials, so weaker Chinese data is typically negative for AUD. If Chinese economic data continues to soften, it could weigh on the AUD in the near term.
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