GBP sees external drivers next weekFed dominates midweekECB to hike on ThursdayWatch UK PMIs on MondayGerman and French inflation due Friday

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The British Pound is under pressure and has lost its crown as 2023's best-performing major currency after it was revealed last week that UK inflation rates had fallen substantially in June and the coming week could see these losses reverse, or accelerate.

This is because we face an action-packed calendar dominated by the Federal Reserve and European Central Bank (ECB) decisions and UK and Eurozone PMI data for July.

And then there are inflation reports from Germany, France and Spain to contend with ahead of the weekend.

The outcomes of all these events will bolster market expectations regarding the outlook for interest rates in the major economies, a key driver of foreign exchange market movement in the current climate.

"The week promises to be exciting," says Tina Haldner, an analyst at Liechtenstein-based private bank LGT. "On Wednesday, the Federal Reserve will announce its monetary policy stance. Financial markets are expecting another rate hike of 25 basis points. On Thursday, the European Central Bank will follow suit and is also expected to raise rates by 25 basis points."

Above: GBPUSD (top) and GBPEUR at weekly intervals.

The Pound to Euro exchange rate slid below 1.16 last week and the Pound to Dollar rate went back below 1.29 following a sharp repricing lower in Bank of England rate hike expectations following news UK headline CPI inflation retreated to 7.9% in June from 8.7% in July, with all sub-components of the data undershooting expectations.

The peak in Bank Rate is now expected at around 5.8%, down from +6.5% at one point earlier in July. The downdraught in expectations has weighed on UK bond yields, a key driver of capital flows that can impact the value of the Pound.

Can this trend extend? Much will depend on Monday's release of UK PMI data for July at 09:30 BST, which will give a timely snapshot of how the UK economy is doing. Half an hour prior we will receive the Eurozone PMIs, allowing for potential volatility in the Pound-Euro exchange rate.

"We expect the Composite PMIs in both the EU20 and the UK to edge lower in July to 49.5 and 52.5 respectively," says Philip Shaw, an economist at Investec.

But it will be the central banks of the U.S. and Eurozone where the lion's share of action in foreign exchange is to be had.

First up is the Fed with a decision on interest rates due to land at 19:00 BST that will likely spark volatility in the Pound-Dollar exchange rate and the broader markets.

Investors are positioned for another 25 basis point hike, however, it will be the guidance as to whether or not another hike is likely which will determine the market's reaction.

Above: Market implied expectations for the future of Fed interest rates. Note the steep expectations for cuts further out. Image courtesy of Goldman Sachs.

Should the Fed suggest it is done with hikes then the Dollar can come under pressure, but any hint that more work needs to be done could prove something of a surprise that would underpin a Dollar recovery.

"A steady message from the FOMC should limit the downside to both front-end rates and USD," says Michalis Rousakis, an analyst at Bank of America Merrill Lynch, explaining Chair Jerome Powell is unlikely to rule out further tightening at the press conference.

The ECB is up on Thursday at midday, with another 25bp hike expected, a decision that will unlikely cause ripples in FX land.

But what could cause some commotion is guidance regarding the September decision: heading into the event markets are priced for a September hike, meaning any pushback against this could result in a slashing of these expectations.

As we noted with the Pound this week, such a development could weigh heavily on the Euro.

Above: Market implied expectations for ECB interest rates.

Last week saw a number of prominent ECB Governing Council members signal that September is not a done deal, raising uncertainty heading into the Thursday event.

Economists at Bank of America reckon the ECB will deliver a last 25bp rate hike next week, underscoring their expectation that support for the Euro will be constrained going forward.

The end of the week could result in yet further volatility for the Pound-Euro exchange rate as inflation data from Germany, France and Spain, is due for release, which should set the scene for the following Monday's all-Eurozone figures.

These outcomes will almost certainly seal the fate of the Eurozone's September decision and determine where the Euro is likely to trade over the coming weeks.