Ebury: Central banks and inflation firmly in focus

By Enrique Diaz – Alvarez *

We have warned that the European Central Bank’s plan to wait until 2023 before raising interest rates in an environment of inflationary pressures was extremely dreamy, and we were fully justified last week. The huge rise in January inflation in the Eurozone set the stage for a bold turn by ECB President Christine Lagarde. Naturally, the common currency soared immediately after the news. The next day, a modest rally in the dollar brought back some of the currency’s losses in the wake of a strong US employment report. However, the dollar ended the week at the bottom of the G10 currency rankings. The euro rose sharply against every major currency except the Swedish krona.

Investor focus will continue to shift between central bank announcements and inflation data, the factors that will dominate foreign exchange markets for the foreseeable future. This week, all eyes are on the US Inflation Report for January to be announced on Thursday, which will again include a record increase of many decades. The focus will also be on speeches by ECB officials, which could provide further support for a euro rally, as the bold tone from last week’s meeting is confirmed.

Sterling

The Bank of England also had some bold surprises for the market, although these were somewhat overshadowed by the surprises that followed shortly afterwards by the European Central Bank. Interest rates rose by 25 basis points as expected, but a strong minority of members pushed for a first 50-point increase, something that had happened since 2004, but the vote came 5-4. The pound rose against the US dollar, but found it difficult to restrain itself against the aggressive change of the ECB and the huge rally of the euro. The focus on Bank of England policy will continue this week, with speeches by Chief Economist Pill (Wednesday) and Governor Bailey (Thursday). Overall, the prospect of aggressive increases and another cheap valuation bodes well for 22 2022.

Euro

The Eurozone has had one of the most significant weeks in recent months. It started with a huge rise in inflation and ended with a 180-degree turn on the subject by President Lagarde at the European Central Bank meeting in February. Not only will asset purchases be completed sooner than expected, but Lagarde has completely abandoned its commitment to wait until 2023 before raising interest rates. The ECB Board is now “unanimously” concerned about inflation and sees “upside risks” in its future course. If the euro has seen a huge uptrend in response to this, we believe there is still room for movement. At the same time, we are not sure that the ECB can wait until September and we expect the euro to remain highly supported, as markets continue to adapt to the ECB’s political shift.

Dollar

Unusually for a week of employment reporting, the course of the dollar depended largely on events on the other side of the Atlantic. However, the report itself appeared very strong despite the distortions brought about by Omicron, with dynamic job creation, upward revisions of previous months’ figures and rising wages, though not enough to keep up with prices, towards currently. It is clear that the US is essentially on a full-time trend, and US Federal Reserve increases are the only tool available to try to contain price pressure. However, it is worth noting that monetary policy operates with “large and variable” delays and, therefore, we believe that interest rates have a long way to go before their effect on prices is felt.

* Chief Risk Officer of the international payment company Ebury. The company’s analysts were named by Bloomberg in the first place of the most successful forecasts for the EUR / USD exchange rate in the fourth quarter of 2020