With UK inflation continuing to decline in September, markets anticipate a potential rate cut from the BoE in November, especially following recent comments from BoE’s Bailey, who indicated the Bank could cut rates aggressively if inflation drops further. Meanwhile, the USD remains supported as market expectations for a November rate cut have diminished, driven by ongoing geopolitical risks and the upcoming US election.

GBP: Focus on the UK’s budget!

GBP has faced a challenging start to Q4, with both global and domestic pressures weighing heavily. Globally, the sharp rebound of the high-yielding, safe-haven USD has driven GBP/USD lower. Additionally, tighter financial conditions, US political uncertainties, and geopolitical risks have dampened risk sentiment, pressuring the risk-sensitive GBP.

Domestically, UK inflation dropped more than expected in September, with services inflation (key to BoE policy) falling to 5.6% y/y from 5.9%. This decline has reinforced dovish views within the MPC, especially after Governor Bailey's recent hints that the BoE might ease more aggressively if inflation continues to decline. Consequently, UK rate markets have priced in a front-loaded easing cycle, reducing GBP's rate appeal. Weaker-than-expected UK PMI also signals cautious business confidence, exacerbated by bleak government rhetoric, budget uncertainty, and international conflicts, adding to an already tense economic outlook.

Near-term attention will focus on Chancellor of the Exchequer Rachel Reeves' autumn statement on October 30. Prime Minister Starmer has indicated this budget will be “painful,” suggesting tight fiscal policy—a typically bearish factor for currency. Meanwhile, BoE officials have yet to confirm a majority backing for accelerated easing; however, any additional dovish signals could further pressure the GBP.

USD: ‘Trump Trade’

With the US election approaching, the improving odds of a Trump victory have reignited "Trump Trades" among fixed-income investors, contributing to a USD rally. This raises a central question for FX investors: how much further could USD strengthen on a Trump win, and how much could it weaken on a Harris win? Beyond election dynamics, the recent USD gains may also stem from a reassessment of the Fed’s dovish outlook amid positive US economic surprises. The S&P Global composite PMI’s unexpected acceleration highlights growth divergence, with a struggling eurozone supporting a USD-positive backdrop likely to persist. As mentioned in last week’s outlook, a Harris victory could trigger a significant USD selloff, similar to the drop following Joe Biden’s 2020 victory, despite USD's current rate advantage and resilient economic indicators.

Looking ahead to next week, USD investors will closely watch the latest Non-Farm Payrolls, ISM, and PCE data. While recent industrial action and the hurricane season in the US might add volatility to labor data, it may have limited impact on the Fed’s November decision. Overall, USD may continue to find buy-on-dip support as the US election approaches as well as still uncertainty in the Middle East tension.