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The US Dollar emerged as the victor following the European Central Bank’s (ECB) dovish policy announcement on Thursday, September 14, 2023, which led to declines in both the Pound to Dollar and Euro-Dollar exchange rates. The ECB’s decision to increase interest rates while simultaneously indicating a pause in future hikes prompted investors to anticipate a similar outcome from the Bank of England next week.
“The dovish ECB hike and another round of strong US activity data sent the dollar on another rally,” said Francesco Pesole, FX Strategist at ING Bank. The Pound to Dollar exchange rate fell 0.65% on the day to close at 1.2408, mirroring the Euro-Dollar’s 0.80% decline.
The ECB stated that interest rates have reached levels that “maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” This suggests no further hikes are imminent in the near term, leading to a drop in Eurozone bond yields and the Euro.
As a result, market expectations for an ECB rate cut have been brought forward to earlier in 2024. Simultaneously, Pesole suggested that another Federal Reserve hike cannot be entirely ruled out due to resilient US economic data causing markets to reprice Fed rate cut expectations quite substantially recently.
These developments in relative monetary policy expectations help explain the losses in the Euro-Dollar exchange rate. However, they also impacted the Pound-Dollar exchange rate due to heightened risk perceptions that the Bank of England will follow the ECB’s lead and hike again next Thursday while signaling that the peak has been reached.
Bank of England’s Governor, Andrew Bailey, has previously stated that the Bank was approaching its final rate hike. This statement led to a fall in the Pound, and further downward adjustments are expected if these comments are confirmed in print when fresh guidance is released on September 21.
The Bank has already raised rates to 5.25%, and despite the elevated level of inflation, further hikes are likely. However, recent data revealing a rising trend in UK unemployment suggests that wage pressures will soon start to fall, easing inflationary pressures. This could mean that the Bank believes its work is done, which could result in further losses for the Pound-Dollar exchange rate.
Before the ECB meeting on Thursday, markets had priced in a 65% implied probability of a 25-bps hike. The ECB went ahead with the rate hike, lifting the main refinancing rate to 4.50% from 4.25%. However, the Euro fell sharply as the ECB strongly indicated that we have reached a terminal interest rate, meaning no more hikes are likely moving forward.
The ECB has expressed more concern about the growth trajectory than the inflation outlook. Rising oil prices may keep global inflation elevated, but the ECB’s aggressive tightening is impacting demand, as evidenced by recent data releases in Germany and the Eurozone. A weakening economy should help bring inflation back down to the target in the medium term, especially when interest rates are now “at sufficiently restrictive levels.”
Consequently, the ECB has cut its growth forecast for 2023 and 2024 while slightly increasing its inflation projections. For 2023, GDP growth was cut from 0.9% to 0.7%, and for 2024 it was reduced from 1.5% to 1.0%. Inflation for 2023 was raised to 5.6% from 5.4%, and for 2024 it was increased to 3.2% from 3.0%.
Investors will be closely monitoring incoming data to gauge how long rates will be held at these levels. However, until there is a significant deterioration in US data sufficient to reverse the Dollar’s bullish trend, the EUR/USD is expected to remain in an overall bearish trend.
This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.
Source: Investing.com
