Central banks take a tougher stance – what happens next?

Sterling is being pulled in two directions. The Bank of England kept interest rates at 3.75% last week, but three of nine policymakers voted for an increase to 4%, suggesting another rise remains possible if inflation persists. Today’s data were less encouraging: UK services activity slowed to a three-month low while firms reported rising cost and selling-price pressures. Government finances add another uncertainty, with August borrowing £3.5bn above the official forecast ahead of the 28 October Budget. For sterling, the question is whether expectations of higher interest rates can continue to outweigh softer economic growth and concerns over the public finances.

The euro has been under pressure from the resurgent US dollar, despite the ECB raising rates by 0.25 percentage points earlier this month. Today brought much better economic news, with the eurozone composite Purchasing Managers’ Index jumping to 53.1 – its highest since April 2023 and well ahead of expectations. Inflationary pressures are rising too, partly due to higher energy costs. That combination of firmer growth and stubborn inflation could keep another ECB rise on the table. Its next monetary-policy meeting is on 29 October, so inflation, oil prices and signs of economic resilience will be closely watched between now and then.

The dollar is back near its strongest level in two months after the Federal Reserve raised its target range by 0.25 percentage points last week, to 3.75–4%. The Fed described economic activity as solid but inflation as still elevated, while policymakers have since kept the possibility of further tightening firmly in view. Markets are now watching whether the economic data justify those expectations, with September’s preliminary US business activity figures due later today. A further run of strong data or persistent inflation could keep supporting USD. Falling oil prices, weaker activity or softer inflation could instead reduce expectations for another rise before the Fed’s late-October meeting.