Dollar to remain under pressure as Fed cuts towards neutral
Last week we published our ‘Global Watch’, setting out our projections for exchange rates and interest rates in 2026. The key call was that we expected the Federal Reserve to cut its policy rate to 3.25%-3.5% by mid-2026, continuing to put downward pressure on the dollar so that the €/$ exchange rate will push into a $1.20-$1.25 trading range early next year. So far, our view looks on track. The ‘dot-plot’ accompanying yesterday’s Fed policy decision indicated the majority of FOMC members see interest rates being cut by a further 50bps to 3.5%-3.75% by December, such has been slowdown in US job creation. The €/$ exchange rate briefly rose above $1.19 following the news.
Last week’s ECB forecasts showed higher spending on infrastructure and defence is expected to prop-up Euro Area GDP growth by 0.25pp in 2026, offsetting any negative impact of uncertainty from US tariffs. In this context, it isn’t surprising ECB policymakers have given a consistent message that the easing cycle is over for now. So we see ECB rates on hold until mid-2026. In contrast, November’s Budget will be a key date for the sterling and UK rate outlook. Should the fiscal consolidation of tax hikes and spending cuts exceed £20bn (0.7% of GDP) it may persuade investors the Bank of England has more scope to cut rates and put sterling under pressure. Nonetheless, on balance, we still see sterling trading in a 84-89p range against the euro into 2026.
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