Ebury: Huge reversal of central bank priorities

By Enrique Diaz – Alvarez, Chief Risk Officer *

The Federal Reserve made it clear at its December meeting that it was increasingly concerned about inflationary pressures, and the dollar reacted accordingly, rising against every G10 currency. Sterling also took part in the rally, as the Bank of England surprised the markets again, suddenly raising interest rates.

Emerging market currencies have largely survived better than the G10 against the dollar, and this is an interesting development that is worth watching. The Turkish pound was once again the exception and collapsed again by 15%, as Erdogan’s policies threaten to dismantle the Turkish financial system.

There has been a huge upheaval in central bank priorities in recent weeks, as evidenced by the Federal Reserve’s aggression, the Bank of England’s unexpected rise and the emerging disagreement at the European Central Bank council. As the news stream turns to the holidays, investors will pay close attention to the news about the Omicron variant. In the new year, the different pace of tightening of central banks will continue to be the main lever in the foreign exchange markets.

Sterling

November inflation in the United Kingdom held another unpleasant surprise, climbing above expectations, to 5.1%, for 2021. This may have been the catalyst for the Bank of England’s sudden rise, after a particularly brave vote 8-1. The Bank specifically cited labor market tightness and inflationary pressures as justifications for the move. We believe that there is a possibility for a continuous sterling rally until the end of the year, given the lack of data, the positive news from the Central Bank.

Euro

The European Central Bank will clearly lag behind globally in this tighter cycle. However, we believe that there were subtle but clear indications that the institution is changing its view of inflation and taking a more aggressive stance. Inflation forecasts revised sharply higher. The Omicron variant was also cited as a possible cause of additional inflation. Finally, President Lagarde suggested the existence of a hawkish dissenting faction within the Council, but acknowledged that the decision was not unanimous. For now, however, Lagarde insists a rise in 2022 remains “highly unlikely” and the euro has struggled to keep pace all week.

Dollar

As expected, the US Federal Reserve has doubled the rate of quantitative easing and will complete bond purchases by March at the latest. However, the announcements by the Federal Reserve, and in particular the “dot plot”, ie the predictions of its members regarding the future interest rates, were bolder than most expected. raising interest rates three times in 2022, and it is clear that the March meeting is the most likely to announce an increase.

President Powell has hinted that the central bank is much more concerned about inflation than in the previous session and that he sees the labor market tending to move towards full employment. While we maintain a generally positive outlook for the US economy, one of the main concerns is what will happen to US interest rates once the Fed’s huge support for the government bond market disappears as markets end in March. 2022.

* 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.