Analysis: Europe's currencies feel fresh pain as central bank support fades

Federated Hermes

21/09/2023 15:41

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      Sterling, Swiss franc hurt after cbank decisions
    

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      Weaker growth, rate cut prospects hurt European FX
    

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      Volatility expected to pick up
    

  
    By Naomi Rovnick and Dhara Ranasinghe
       LONDON, Sept 21(Reuters) - There's no respite for
struggling European currencies as a likely pause in central bank
interest-rate rises and a weakening economic outlook puts the
focus on prospective rate cuts ahead.    
    Sterling slid to a more than six-month low  GBP=  against
the dollar on Thursday, even after the Bank of England held
rates at a 15-year high and pledged to raise borrowing costs
again if it cannot tame inflation. 
    The Swiss franc  CHF= , one of this year's best performing
major currencies versus the dollar, fell almost 1% at one point
after Switzerland surprised markets by pausing its rate rise
cycle. 
    Meanwhile, Thursday's quarter-point rate rise in Sweden
failed to provide much respite for the battered Scandinavian
currency, which is down over 6% against the greenback so far
this year.
    In short, the outlook for currencies in Europe is bearish,
analysts and investors say, citing a strengthening dollar and
stagnant economic growth in European nations as oil prices rise.
    "We are turning to a bigger focus on growth than what
central banks do," said Kit Juckes, global head of currency
strategy at Societe Generale. 
    SOUNDING HAWKISH 
    The BoE offered mixed messages by pledging to stay tough on
inflation, still more than triple its 2% target, while noting
that economic growth was slowing. 
    The European Central Bank last week lifted rates to a record
4% and upgraded its inflation forecast for 2024, but the euro
 EUR=EBS  fell and has lost almost 2% against the dollar this
month. 
    SocGen's Juckes said the euro was "headed for a look at
parity," in a reference to the $1 marker.
    The ECB, like the U.S. Federal Reserve, has pushed the idea
of rates staying higher for longer. This backdrop should support
a currency but in the euro's case, traders are homing in on the
region's economic underperformance and betting the ECB will be
forced to cut before the Fed. 
    Overall, Europe's central banks "would like to portray this
idea of higher for longer (rates)," said Ed Hutchings, head of
rates at Aviva Investors. But markets, he said, were "getting
ahead of this."    
    Sweden's Riksbank raised its key rate by 25 bps to 4% and
said it may need to do more to bring inflation lower. The
currency, which the central bank labeled "unjustifiably weak,"
barely caught a break and remains near a record low against the
euro  EURSEK= . 
    Sweden's economy, hurt by turmoil in the real estate market,
is expected to contract this year. 
    In fact, the only central bank whose hawkish tones have
struck a chord with markets is the Fed, which on Wednesday held
rates steady but signaled one more rate rise this year. 
    The dollar index  =USD  which measures the U.S. currency
against peers, is near its highest in over six months.
    This, said Manulife Investment Management chief investment
officer Nathan Thooft, is because "the data suggests the U.S.
economy right now is much better than much of Western Europe." 
    He expected one the of big European central banks to be the
first to cut rates. 
    Economists polled by Reuters expect the euro zone economy to
grow 0.6% this year, the UK to expand 0.4% and the United States
by 2%. 
    "As we become more data dependent, currencies swing around
with every bit of data that's available," said Bjoern Jesch,
global chief investment officer at DWS Group.    
    The push and pull in market expectations ahead of rate
decisions, as has been the case in Britain and the euro area
this month, highlights rising volatility around central bank
meetings.
    Nomura expects sterling to weaken to $1.22 by end-October,
from $1.23 now; ING economists said the Swedish crown remained
"vulnerable." 
    
    VOLATILITY 
    Another driver of dollar strength is oil prices, trading
near 10-month highs above $90 a barrel  LCOc1 .
    "The U.S. is an oil producer so it tends to get hurt very
little by higher oil prices whereas Europe and Japan get hit
more," said Barclays global head of FX strategy Themos Fiotakis.
    European central banks were "in a bind," Fiotakis added, as
higher oil prices also threatened to push inflation higher.
    This made rate cuts bets in Europe seem vulnerable, said
Orla Garvey, senior fixed income portfolio manager at Federated
Hermes. 
    "Growth and inflation data will be more volatile going
forward and this in itself will create higher market
volatility," she said.                 

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Currency performance against the dollar this year    https://tmsnrt.rs/452k2yu
The race to raise rates    https://tmsnrt.rs/44ZQXDM
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 (Reporting by Naomi Rovnick and Dhara Ranasinghe; editing by
Christina Fincher)
 ((Naomi.Rovnick@thomsonreuters.com; +442075422684;))