Foreign Exchange Commentary

Summary

• U.S. CPI rose 0.2% MoM in April; YoY inflation fell to 2.3% (lowest since 2021); core CPI remained at 2.8%.
• New Trump tariffs (25% on imported cars, increased China duties) not yet affecting inflation; expected to push prices up by mid-year.
• U.S. and China reached a 90-day tariff truce, U.S. cut planned tariffs from 145% to 30%, China from 125% to 10%, boosted trade activity.
• U.K. Q1 2025 GDP rose 0.7%, beating expectations (0.6%) and prior quarter (0.1%); strongest growth in over a year.
• U.K. growth partially driven by front-loading orders ahead of U.S. tariffs.
• Eurozone inflation eased; Germany’s HICP fell to 2.1% in April from 2.2%. Headline inflation may drop below ECB’s 2% target

United States and the Dollar
U.S. inflation showed signs of cooling in April with consumer prices rising 0.2% month-over-month, bringing year-over-year CPI to 2.3%—the lowest annual increase since 2021. Core CPI also grew 0.2% monthly, maintaining a 2.8% annual rate which was pretty much in line with market expectations.

Recent tariffs announced by the Trump administration, including a 25% levy on imported cars and increased levies on Chinese goods, do not seem to have impacted inflation figures yet, most of the tariffs will start taking effect later this summer. Economists anticipate these measures will increase prices by mid-year, though current moderation in inflation is likely stemming from softening demand.

In terms of monetary policy, the Federal Reserve maintained its policy rate at the May meeting, and continues with its patient, data-dependent approach. Policymakers continue to point to moderating inflation and a resilient labor market as reasons for holding rates at current levels.

The highlight for the week is the trade talks between the U.S. and China this past weekend, which resulted in a 90-day U.S.-China tariff truce, reducing market angst around tariffs. The U.S. lowered planned 145% tariffs to 30%, while China lowered retaliatory tariffs to 10%, boosting bilateral shipping volumes and supporting the Federal Reserve’s cautious stance.

While monetary policy remains stable, fiscal policy appears to be turning increasingly expansionary. This week, the House Ways and Means Committee approved tax cuts totaling approximately $5 trillion over the next decade, alongside reductions in Medicaid and green energy subsidies.

Initial commentary in the market suggests this plan could add $3.8 trillion to federal deficits through 2034, and that drove U.S. 10-year Treasury yields to a three-month high of 4.54%.

The divergence between tight monetary policy and the possibility of more expansionary fiscal measures are expected to create a complex economic environment in coming months.

In terms of price action, The U.S. Dollar Index (DXY) experienced significant volatility this week. The index initially surged 1.44% on Monday to 101.79, driven by the announcement of a 90-day U.S.-China tariff truce and U.K. trade progress, but this momentum reversed Tuesday following April's inflation report. Soft inflation figures strengthened market expectations for potential Federal Reserve rate cuts, influenced by speculation that the U.S. administration might favor a weaker dollar in trade negotiations, particularly following reports of exchange rate discussions with South Korea.

United Kingdom - British Pound Fluctuates Amid Trade Developments and Economic Data
UK GDP grew 0.7% in Q1 2025, outperforming the previous quarter's 0.1% and exceeding forecasts of 0.6%. This represents the strongest quarterly growth in over a year, providing momentum for Prime Minister Keir Starmer's government.

Finance Minister Rachel Reeves highlighted that the UK outperformed the U.S., Canada, and major EU economies, attributing the growth to increased infrastructure spending and pro-investment reforms. Business investment rose nearly 6%, the largest increase in two years.

Market analysts caution this growth may be temporary, partly driven by accelerated orders anticipating new U.S. tariffs. The remainder of 2025 will present challenges mainly in the form of new trade barriers for British export sector, including a 10% U.S. tariff on most UK goods despite a recent metals agreement.

The British Pound declined nearly 1% against the dollar on Monday, May 12, reaching a four-week low of $1.318, primarily due to dollar strength following the U.S.-China tariff truce announcement.

The pound recovered to $1.32115 by Tuesday, supported by the soft U.S. inflation data. Recent UK trade agreements with the U.S. and India also improved market sentiment toward British trade prospects.

By Thursday, sterling rallied to $1.3306, supported by strong UK GDP data and slowing U.S. retail sales. However, gains were limited by concerns that GDP figures might overstate economic performance, while BoE Chief Economist Huw Pill warned UK inflation could exceed forecasts.

Europe - Euro Experiences Volatility Amid Monetary Policy and Inflation Developments
Europe’s economic policymakers are currently balancing encouraging inflation data against worries about future price risks. In the euro zone, inflation is still trending lower – for example, Germany’s inflation eased to 2.1% in April, down from 2.2% in March. With energy costs down and growth sluggish, headline inflation could drop below the European Central Bank’s 2% target in the near term, some officials say.

The ECB has been steadily cutting interest rates the last 12 months, lowering rates seven consecutive times bringing the deposit facility rate to 2.25% to support the economy as price pressures receded.

Traders and investors now expect another 25 bp rate cut in June, which would take the ECB’s policy rate to 2.0%. But Isabel Schnabel, one of the more hawkish ECB members, warned that the euro area faces potential price pressures in the medium term.

Speaking at a conference last Friday, Schnabel argued that while inflation may fall below 2% temporarily, it is necessary to keep a steady hand and hold interest rates at current level and maintain financial conditions relatively tight. Mrs. Schnabel pointed to two main factors that could push inflation above target in the coming years: fiscal stimulus and trade disruptions.

Euro zone governments are loosening their fiscal stance, which will stimulate demand and could create inflationary pressures over the medium term. The most notable example is Germany’s commitment to boost defense and infrastructure spending.

Additionally, U.S. tariffs along with global trade fragmentation could potentially rise costs. Schnabel noted that even without retaliation, Trump’s tariffs on imports can lift production costs throughout supply chains, making many goods more expensive. If Europe were to retaliate with its own tariffs, that would amplify the effect. Given these dynamics, Schnabel cautioned that “risks to euro area inflation are likely tilted to the upside” over the medium term.

In terms of price actions, the euro fluctuated significantly against the U.S. dollar. After dropping 1.42% to 1.108 on Monday following the U.S.-China tariff truce announcement, it rebounded to 1.121 by Thursday, supported by softer U.S. inflation data and Federal Reserve rate cut expectations.