EUR to underperform the USD in the months ahead

The Federal Reserve (Fed) will start tapering this month, while the European Central bank (ECB) said it is “very unlikely” to raise rates in 2022, and the Bank of England (BoE) surprised markets by holding rates.

The FX market has returned to the ‘relative’ stories once again where the outlook for the Fed’s monetary policy remains in contrast to that for other central banks, for example, the very dovish guidance being provided by the ECB. The case for the EUR as a funding currency (which often has a low-interest rate) continues to build. As such, we expect the EUR to underperform the USD in the months ahead.

The BoE voted 7-2 to keep its policy rate at 0.10%. The MPC also voted 6-3 to continue with the existing quantitative easing (QE) program, which in any case is scheduled to end next month. The BoE cut its growth projections but raised its inflation projections for this year and next. All this suggests ‘modest’ tightening is coming. A rate hike in February 2022 is the consensus amongst leading economists, while the 16 December meeting is very much live.

Beyond the BoE’s fairly hawkish hold, analysts remain cautious on Sterling, given the likely limited scale of rate hikes going forward, a deteriorating current account deficit, and less fiscal support for the UK economy than before.

The Reserve Bank of Australia dismiss higher inflation

The Reserve Bank of Australia announced its monetary policy decision on Tuesday, leaving the cash rate at 0.10% as expected. The central bank will continue to purchase government securities at a rate of Aussie $4 billion a week until at least February 2022 and formally dropped the 10 basis point target for the April 2024 bond.

RBA Governor Philip Lowe cooled down speculation of a soon-to-come rate hike after saying that markets overreacted to the recent inflation data, spurring the AUD/USD sell-off. According to Lowe, there is still considerable uncertainty on wage growth, and it would be “extremely unlikely” for inflation to jump well beyond RBA projections and warrant earlier rate hikes.

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