Dollar falls on sharply rising risk appetite; ECB 'hawkish'

20 Jun. 2023

Both the Federal Reserve and the ECB showed their hard side last week, with the ECB raising interest rates and the Fed not. Yet the markets were persuaded by the facts and not the rhetoric. The dollar sold off heavily. The currency fell against all major currencies in the world, with the exception of the Japanese yen. The latter suffers a lot from the behavior of the Bank of Japan, which pretends that it is still 2020.

The British pound was the best performer last week. The exchange rate rose by almost 3% against the dollar, pushing the pound to the top of the weekly rankings. Latin American currencies continue to excel so far this year, with the Colombian peso, the Mexican peso and the Brazilian real rising by double digits against the US dollar.

This week, the focus is on the United Kingdom. Just like last week in the US, in the UK the May inflation figures will be released just before the Bank of England meeting, which takes place on Thursday. Markets are almost unanimous in agreeing that the MPC will raise interest rates by 25 basis points. By the end of the week, we will get the preliminary PMI indicators for global economic activity. In the U.S., it's going to be an unusually quiet week. Investors will be turning their attention to other regions, especially the British pound. Below are the major currencies in detail.

Euro

The ECB was clearly hawkish last week. They raised interest rates and committed to another rate hike in July. Above all, this central bank looked beyond the recent downside surprise in inflation and undoubtedly remains focused on the difference between interest rates and core inflation, which is still significant. An interest rate decision is also expected in September. We think interest rates will continue to be hiked then, unless inflation causes a significant downside surprise in the meantime. The markets are now starting to align with our view. The exchange rate of the single currency is rising to the upper limit of its recent trading range against the US dollar.

British Pound

The combination of persistent inflation, signs of a wage-price spiral and a resilient economy is driving up market expectations for both the Bank of England's terminal rate and the pound rate. We have always bet on the pound this year and are pleased that it is at the top of the G10 tables so far. In our view, there is also room for further price increases. We expect inflation to be at an all-time high again, the Bank of England to raise interest rates this week and a hawkish tone. It is likely that interest rates in the UK will exceed 6%. We remain bullish on the pound.

U.S. Dollar

The Federal Reserve went into 'hawkish' pause mode last week, leaving interest rates unchanged for the first time during this hiking cycle, but tried to make it clear to markets with an aggressive dot plot that the next step is likely to be a rate hike. That point cloud indicated that most members of the FOMC still expect two further rate hikes before the end of the cycle. The inflation figures of the day before did not help the Fed. The key sub-index for core inflation rose by 0.4% or more for the sixth month in a row. This indicates an undesirable stabilisation of inflation around the 5% level. Markets are still not convinced that the Fed will raise rates two more times, but it is striking that all the expected rate cuts have been pushed back to 2024 – as we thought.

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.

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