Currency exchange rates ready for holiday lethargy (Daily analysis 17.12.2021)

A marathon of central bank meetings failed to shake the currency market in the last market-full week of this year. The dollar lost ground against the pound, the franc and the euro.

In a nutshell, the world's most important central bankers have not been frightened by the new variant of the coronavirus. If anything, they fear that another wave of the disease could temporarily slow growth, as well as permanently and severely exacerbate problems with out-of-control inflation.

Central banks have been in the limelight

The Federal Reserve will accelerate the tapering of asset purchases and is preparing for as many as three rate hikes next year. Rates have been raised in Norway (a planned second hike in the cycle) and the UK (an unexpected start to normalisation despite record infections and the rapid spread of omicron).

As a result, the pound is the strongest of the main currencies. During the week, it rose by around 0.5%, and the GBP/USD pair is valued at about 1.33. Despite the abundance of news from the monetary policy front, the euro or the franc have fluctuated even less. The EUR/USD is above 1.13, but the November 30 high has not been overcome. In Conotoxia's currency forecasts, we assume that the highs of the dollar's strength are behind it. Rising interest rates, much faster than in the eurozone, will undoubtedly be a strong asset for the US currency, limiting the scale of its depreciation. We expect that at the end of March, the exchange rate will rise from the current levels of 1.13 to 1.15, i.e. by less than 2%.

The franc exchange rate indifferently passed the central bank meeting. The monetary authorities still believe that the currency is overvalued and intend to counter its strength. Their enthusiasm is tempered by the fact that low EUR/CHF levels could help to limit the strong rise in inflation. A rising but on a global basis low inflation (1.5% year-on-year in November) can be welcomed after years of deflationary threats. We believe that the franc should not be significantly stronger than it is now. A clear and strong trend of the franc weakening against the main currencies will have to wait until the European Central Bank starts to think more boldly about raising interest rates.

The euro: ECB seeks its identity

This is not likely to happen in the coming months. At yesterday's meeting, the decision to end the pandemic emergency asset purchase programme (PEPP) in March was outlined. Still, it was noted that there is a chance to use this tool if the deterioration of economic fundamentals by the pandemic requires it.

At the same time, the scale of the "traditional" APP purchase programme in the second quarter was increased to 40 billion EUR per month. In other words: the monetary stimulus for the economy will continue to flow, but with a different tool. Its reduction in the second half of next year is to proceed at the rhythm of 10 billion EUR per month. In summary, the very soft stance that has been a drag on the euro against the franc or the dollar in recent months has been maintained.

It should be added that inflation forecasts have been revised upwards. It is expected to reach 2.6% for the consumer price index and 1.9% for core prices next year. If it starts to turn out that they are still too low, and price pressures change their character and cease to result from disruptions in supply chains and one-off factors, the door may open for a quicker abandonment of the soft stance and faster consideration of interest rate rises. At present, markets are not ready for such a scenario, and it would be a chance for clear rises in the EUR/USD pair, which would help push the USD/PLN lower. Although it is a distant story for now, we expect a more positive narrative to crystallise around the eurozone economy next year (growth in Germany will shake off its current woes). This will be traditionally positive for the CEE3 and Scandinavian currencies, a catalogue that is perceived in the financial markets in terms of so-called satellites, currencies that are strongly linked to the economic situation in the eurozone.