Currency outlook: Pound bolstered by Covid optimism, Euro undermined by ECB’s dovish bias

EUROZONE: Economic activity is likely to have weakened in the last quarter of 2021.

Euro
EUR/GBP: Down from £0.85 to £0.83
EUR/USD: Unchanged at $1.13
The euro trended broadly lower over the past four weeks, mostly as a result of the perceived policy divergence between the European Central Bank (ECB) and other major central banks, with the ECB’s dovish bias undermining the single currency.
Whilst its peers look ready to embark on a new tightening cycle, the ECB remains committed to maintaining its ultra-loose policy as it continues to dismiss inflationary pressures in the Eurozone as ‘transitory’.
Recent Eurozone data releases have also acted as a headwind for the single currency in recent weeks as they indicate economic activity is likely to have weakened in the last quarter of 2021.
Meanwhile the euro has also been pressured by Europe’s ongoing Covid woes, with many countries within the Eurozone reporting record increases in daily cases, raising additional concerns over the bloc’s economic recovery.
Looking ahead, the contrast in monetary policy between the ECB and other major central banks may become an increasing liability for the euro over the coming month, while the threat of a potential conflict in neighbouring Ukraine may also supress EUR sentiment.
Pound
GBP/EUR: Up from €1.17 to €1.19
GBP/USD: Up from $1.32 to $1.35
The pound enjoyed a strong start to 2022, with the currency carrying over the positive momentum it saw at the end of 2021
A key factor underpinning Sterling sentiment over the past month was the UK government’s decision not to impose stricter Covid restrictions in England and to instead ‘ride out’ Omicron.
Further buoying GBP exchange rates were considerable bets the Bank of England (BoE) will hike interest rates again at its first policy meeting of 2022.
However the pound’s ascent hasn’t been completely frictionless, with the currency being shaken by political jitters in recent weeks as Boris Johnson faces a potential leadership challenge after the Prime Minister admitted he attended a ‘bring your own booze’ party in the Downing Street garden during the first lockdown in May 2020.
It seems safe to assume that the BoE’s February policy meeting will be the primary focus for GBP investors in the coming month. With a February interest rate hike already largely priced in by markets the focus will instead be on the bank’s forward guidance.
If the BoE signals plans for the current tightening cycle to accelerate then the pound is likely to maintain its positive trajectory.
US Dollar
USD/GBP: Down from £0.75 to £0.73
USD/EUR: Up from €0.87 to €0.88
The US dollar stumbled over the finish line in 2021, with easing fears over the Omicron Covid variant resulting in demand for the safe-haven currency waning.
However the US dollar didn’t stay on the defensive for long, with the currency catching fresh bids in January amidst growing speculation the Federal Reserve could begin hiking interest rates earlier than previously thought.
Bets the Fed could start raising rates from March – once it finishes tapering its stimulus programme – helped to drive US Treasury yields higher, which also helped to underpin USD exchange rates in recent weeks.
Elsewhere, elevated geopolitical uncertainty also lent strength to the ‘greenback’, with tensions between the West and Russia and China spooking investors.
Acting as a headwind for the US dollar however has been the continued disappointment in US employment data, with the US economy adding fewer than half the number of jobs expected in December. The Fed’s first policy meeting of the year could act as a key catalyst for the US dollar going forward.
Analysts are currently predicting the Fed will deliver up to four rate hikes in 2022 and any signals from the bank confirming this are likely to bolster USD exchange rates.
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