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The rates of the G10 currencies are still in sync with the 'hawkishness' of the relevant central bank – which is measured against the consensus. It is extremely 'dovish' and assumes that monetary policy in the developed countries will remain extraordinarily accommodative.
The British pound took a nosedive after the Bank of England's surprise decision not to raise interest rates. The exchange rate of the dollar, on the other hand, remained stable after the Federal Reserve's announcement that it will reduce its bond purchases, as the market had largely expected this. The greenback ended last week on the upside, following Friday's strong jobs report. The euro is still struggling: ECB President Lagarde insists that she is not worried about inflation and has postponed expectations of interest rate hikes over time.
For the foreseeable future, inflation-related figures are the most important. We get producer price inflation (Tuesday) and CPI (consumer price index, Wednesday) this week. Both indicators, which have already risen sharply, are expected to rise further. Several speeches by Federal Reserve officials are scheduled for the course of the week. We maintain our expectation that divisions will grow over whether ultra-loose monetary policy is still the right tool as inflation remains well above target for much longer. Below are the major currencies in detail.
ECB President Lagarde remains 'dovish' and is not worried about rising inflation, which means that the common currency still faces a lot of headwinds. We have therefore revised our forecasts for the euro downwards. The fact that inflationary pressures are persisting for longer than expected is, in our view, clearly a global phenomenon.
Inflationary pressures occurred first in the US and now, with a lag, also in the eurozone – as is often the case with macroeconomic trends. This slowdown does mean that the ECB can stick to its optimistic forecasts, in which inflation is temporary, for a while longer. It is difficult to imagine a real rally in the euro in this situation.
The Bank of England seems to have messed up its market communication quite a bit. For weeks, hawkish signals were issued, but then the MPC went completely against market expectations at its November meeting by not committing to a specific date. The pound was completely out of control and became one of the worst performers in the world.
This week, attention will return to the earnings releases. Inflation in the US is, of course, the key data point for USD/GBP, but September GDP numbers from the UK will highlight the pace at which the services sector is recovering from the disruption caused by the delta variant.
At its November meeting, the Fed decided to taper its purchases of government bonds and mortgage bonds. This was broadly in line with our expectations and those of the market. We expected the announcements to have a hawkish tinge, but Chair Powell still clearly supports the assumption that inflation is transitory, despite the fact that the Fed did not foresee the inflation peak coming, nor did it foresee its level and duration. The dollar fluctuated a bit due to this 'dovish taper', but after the publication of the strong job market report the next day, the currency regained its course.
Everyone is now looking forward to Wednesday's inflation report. A strong increase in both the headline and the core figure is expected again. We don't think there will be an immediate response to this with policy changes, but the Fed can't continue to ignore these numbers indefinitely.
By: Enrique Diaz-Alvarez
Enrique Diaz-Alvarez is chief risk officer and heads Ebury's analyst team in New York. Because of his drive, passion and thorough knowledge, Enrique is recognized by Bloomberg as one of the most accurate predictors of market movements.
About Ebury:
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