Dollar's correction, pound's disappointment (Daily analysis 25.06.2021)

The sentiment on world markets has calmed down. The equity markets returned to all-time highs; the dollar lost its temper, oil rose (in London over 75 USD per barrel). Main emerging market currencies gained against the euro and the dollar.

All G-10 currencies are appreciating against the dollar this week except for the safe-haven, defensive yen, for which demand is weak in the current environment. The EUR/USD is back above 1.19, with Scandinavian currencies leading the way. In the EM space, the best performing currencies are those whose central banks raised rates this week: the Czech koruna, the forint and the peso. The zloty is also strong, as well as the ruble supported by the situation on the oil market.

Pound's below in red despite Bank of England optimism

The pound - given the characteristics of the currency - showed relative resilience to the recent dollar rally. This was due to expectations that the Bank of England could normalize policy relatively quickly and raise rates earlier than the Federal Reserve. One can assume that the key to the hierarchy of currencies in the coming quarters will become the tendency of individual central banks to normalize policy. At yesterday's meeting, the UK monetary authorities presented an optimistic outlook on the economy but stayed silent on the timing of a rate hike. This became a premise for a moderate weakening of the pound against the euro and the dollar.

On a larger scale, we look at the British currency negatively. Inflation in the UK is accelerating, but it is hard to see how its two percent growth rate can be interpreted as a sign of a growing threat that prices are out of control. The pound has had its five minutes thanks to the faster progress of vaccination and the lifting of restrictions. What was unique a few months ago, however, is becoming universal today. While demand in the UK economy will be robust, economic activity will rebound more dynamically where restrictions were loosened later, such as in the eurozone. Brexit may also cause an economic upturn, as not only will it lower the growth potential, but disputes and disagreements between Brussels and London will come to the front. Uncertainty is also created by the appearance of a new variant of the coronavirus.

Hungarians give the signal

Policy tightening has begun in the CEE3 region. Hungary was the first to raise interest rates. The benchmark rate was raised from 0.60 to 0.90% and the perceived as a more important deposit rate by 15 basis points. This is in line with concerns that inflation may be getting out of control. Price growth in May was 5.1%, and maintaining its steep path in the coming months is implied in the central bank's forecasts. An increase in the cost of money in Hungary has been a foregone conclusion for a long time. Nevertheless, the outcome of the meeting is favourable for the forint. The crisis policy is fading faster than it could have been expected. This judgment is justified because possible hikes were announced every month (rather than one per quarter). In other words: the tightening cycle may be more condensed in time and decisive than the market had priced in.

This is because the central bank of Hungary's projections assume that price dynamics will return to the inflation target (3%) next year. If this scenario does not materialize, the monetary authorities will reach for further increases. MNB policy should be seen as positive for the forint. For years, the Hungarian central bank was perceived as the most dovish in the region. This assessment is outdated today - Poland's monetary policy is the mildest in CEE3.

The Czechs reacted immediately

The Czech National Bank took a similar step a day later: the cost of money was raised by 25 basis points, from 0.25 to 0.50%. Importantly, as in the case of the MNB, the communication accompanying the rate hike is clearly beneficial for the currency. It appears that the CNB will also consider the need for further interest rate moves from meeting to meeting. There are many indications that the intention is to quickly make several rate hikes to try to keep the threat of an excessive increase in inflationary pressures under control. This is rooted in the economy's resilience to the third wave of the pandemic and the excellent condition of the labour market and is reflected in the central bank's new projections. In the Czech Republic, the base scenario is three rate hikes this year at consecutive meetings. A lot will depend on the strength of the koruna - its strong appreciation (e.g. decrease of the EUR/CZK to 25.00 as forecast by us) may mitigate the belief that further changes in the cost of money are needed.