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Last week it became clear that we were right. After the sharp upside surprise in eurozone inflation in January, the way was clear for Lagarde to become hawkish. Of course, the exchange rate of the single currency skyrocketed after this news. The dollar managed to make up some of its losses with a modest rally due to a strong U.S. jobs report, but the greenback still ended at the bottom of the G10 rankings last week. The exchange rate of the euro rose sharply against every major currency, with the exception of the Swedish krona.
Trade attention will continue to be focused on central bank announcements on the one hand and inflation rates on the other, as these factors will determine the currency markets for the foreseeable future. This week, everyone is looking forward to the January U.S. inflation report, which will be released on Thursday. Forecasters have cautiously noted a further rise in inflation – which is already the highest in decades. Speeches by ECB representatives will also be given due attention. If the hawkish shift seen at last week's meeting is confirmed, it could further fuel the euro's rally. Below are the main currencies in detail.
For the eurozone, it was one of the most memorable weeks in many months. The week started with a sharp upside surprise in inflation and ended with a 180-degree turn by President Lagarde at the ECB's February meeting. Not only is it stopping asset purchases earlier than expected, but Lagarde also fully backtracked on her promise not to raise interest rates until 2023. The Governing Council is now 'unanimously' concerned about inflation, and sees upside risks in its further course. Euro prices jumped sharply after this news – but we think there is still more room for price increases. We wonder if the ECB can wait until December and think the euro will hold enough support as markets continue to adjust to the ECB's policy pivot.
They were a bit overshadowed by the surprises from the ECB that immediately followed, but the Bank of England also had 'hawkish' surprises for the market. Although rates were raised by 25 basis points as expected, there was a strong minority, which almost pushed through the first 50 basis point hike since 2004 but narrowly lost the vote, by 5 to 4. The British pound rose against the US dollar, but struggled with the ECB's hawkish turn and the euro's impressive rally. This week, the focus will continue to be on central bank policy. Speeches by chief economist Huw Pill (Wednesday) and Governor Bailey (Thursday) are scheduled to speak. Overall, the outlook for the pound for 2022 is good, as aggressive rate hikes are expected and the currency still has a low valuation.
In a week when an employment report is published, it doesn't happen very often: the exchange rate of the US dollar was mainly determined by events on the other side of the pond. The jobs report proved to be very strong despite the disruptions caused by Omicron. Job growth was strong, previous months' figures were revised upwards and wages rose – although wage increases have not yet been able to keep up with price increases. In the US, there is clearly full employment. Interest rate hikes by the Federal Reserve are the only tool that can try to contain price pressures – with the caveat that monetary policy only has a "long and variable" lag and we believe that interest rates still have a fairly long way to go before any impact on prices is felt.
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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