Increased Volatility in Currency Markets
We continue to focus on EUR/USD, GBP/USD, and EUR/GBP
Avid readers of our weekly currency report will know we have highlighted the importance of the central bank in the coming 12 months and how their actions surrounding interest rates and the tightening of monetary policy will have a significant impact on the currency markets. We believe that as central banks increase interest rates, we should see an increase in FX volatility – interest rate differentials being one of the major drivers of global currencies.
Our first interlude into this theory was proved correct, as we saw huge Dollar buying post the Federal Reserve meeting last Wednesday – see chart below for the move lower in EUR/USD. The Fed Chair Powell delivered a more hawkish speech during the press conference after which the market has subsequently priced in more US interest rate hikes for 2022 than was previously thought.
EUR/USD sells off-post-Federal Reserve Meeting – over 3%…….
What a difference a week makes –
The market’s fickle nature has kicked in this week, as it now turns its attention to the two central bank meetings today – the Bank of England and ECB.
Although in theory, both central banks are at very different stages on the monetary policy curve, the market is getting excited about both, and the Euro and the Pound have rallied back this week versus the Dollar.
Bank of England – a full 25 bps hike is priced in by the market for the BOE today, which would bring interest rates in the UK to 0.5% – noon London time. With 25 bps pretty much a done deal we feel, the question then arises as to whether this is a hawkish hike by the central bank, indicating there are more hikes around the corner or whether they will adopt a more cautious approach. A hawkish hike should lead to an appreciation of the currency and in particular versus the Euro. The hike would increase the interest rate differential between the UK and the Eurozone. We have already seen a strong downtrend emerge in EUR/GBP over the past 12 months or so – where the Sterling has gained in strength versus the Euro – this trend could well continue if the BOE produce a hawkish interest rate hike today – see chart
EUR/GBP – downtrend – GBP strength – 10% since Dec 2020
We also get the interest rate decision from the ECB and Lagarde today where no change in monetary policy is expected – 12.45 pm London time. There are however some elements of the market that are looking for the ECB council to acknowledge the inflation pressures in Europe and to possibly pivot more hawkish in their outlook…… watch this space…..