Will the USD continue to undermine the Euro and the Pound?

The Bank of England has kept the UK base interest rate at 5.25%.

Just like last week’s ECB meeting, the Bank of England has kept the UK base interest rate at 5.25%. While we saw that decision too as a tough call, we were pretty clear that the euro was likely to fall whatever the outcome. In the event, the ECB hiked (when we had anticipated no change) but the euro did, indeed, slip as the bank strongly hinted that the hike would be the last in this cycle provided economic data turned out broadly as anticipated. It is that policy is being driven by the data and hence currencies, such as the euro and the pound are likely to be guided by the data rather than how central banks respond to that data.

To make this clearer, the data in the UK has undoubtedly become more consistent with the idea that the end of the rate-hike cycle is very close, if not here already. In response to this deterioration of activity data, and fall in inflationary pressure, the pound has slipped over the past month having previously rallied since March. In fact, such is the concern about monetary overkill that a rate hike would be the worst outcome for the pound over time, if not initially, because it would really ramp-up recessionary fears.

Mr. Steve Barrow, Head of Standard Bank G10 Strateg, said with data seemingly dictating an end to rate hikes from the ECB and BoE, it seems reasonable to assume that both the euro and the pound will weaken significantly, especially against the dollar given that the data flow in the US is not as conducive to the conclusion of the rate-hike cycle as it is in the euro zone and UK.

However, an important point in Mr. Steve Barrow’s view is that even if US data does not currently make an unequivocal case for an end to the rate-hike cycle, it is likely to do so in time. For while it might be possible for the US economy to roar ahead while others stagnate for a short period of time, it is extremely unlikely to stay that way over the long haul.

Instead, it is more likely that US data will drift towards a more European-like weakness and that this will start to change the Fed’s narrative. This change is likely to weigh on the dollar in the future just as the nuances from the ECB and BoE decisions might weigh on the euro and the pound right now.

“We dare say that the currency response to a change in the Fed’s narrative about policy will be substantially greater than we are seeing in the case of the euro and the pound at the moment. This is because Fed policy and the dollar drive the global monetary cycle and if there’s a perception that this cycle is about to halt in terms of rate hikes, and then move to cuts, we dare say that this is likely to bring much more weakness in the dollar in the future than the weakness in the euro and the pound that we might see right now. This being said, the sine qua non is that this transition from the Fed lifts sentiment and pulls asset prices higher. An end to US rate hikes and the prospect of cuts needs to happen in the context of improved financial market sentiment or else the dollar will rise further”, said Mr. Steve Barrow.