The British pound moved above $1.25 for the first time in 10 months and the euro was approaching its highest level in a year as the U.S. dollar weakened in response to revised expectations for interest rate rises by the Federal Reserve.
Sterling
GBPUSD,
was up 0.7% on Tuesday to $1.2057, while the euro
EURUSD,
rose 0.2% to $1.0931, just shy of its highest in a year. The dollar index, or DXY
DXY,
was off 0.2% to 101.86.
The DXY has lost 3.6% over just the past month, as worries that stresses in the U.S. banking system will hobble economic activity have caused investors to bring forward the time they reckon the Fed will start cutting interest rates again.
A few months ago, markets were pricing a peak for Fed rates of about 5.6% in September. Now that so-called terminal rate is 5%, expected to be held until June.
“The Fed was the most aggressive to tighten and at first blush, the USD may have the most to lose on the unwinding of policy expectations,” said John Hardy, head of FX strategy at Saxo Bank.
Meanwhile, stubbornly high inflation across Europe is seen forcing the Bank of England and European Central Bank to remain comparatively more hawkish.
Data published last week showed the Fed’s favored inflation measure, the PCE index, recording its slowest increase in more than a year in February, while U.K. consumer price inflation, albeit a different measure, accelerated to 10.4% the same month.
European core inflation is exceeding that of the U.S. at a record rate, according to George Saravelos, strategist at Deutsche Bank, with labor costs growing at a faster speed than the U.S. for the first time in a decade.
Source: Deutsche Bank
“What happened the last time the gap between Europe-U.S. inflation was so wide in favor of Europe? ECB rates were above Fed Funds, the 1-year rate differential had a positive 100bps [basis points] spread in favor of Europe and EUR/USD was at 1.40,” said Saravelos.
The ECB’s deposit interest rate is currently 3% and the BoE’s bank rate is 4.25%.
In addition, investors are relatively less concerned about the European banking system and any credit crunch that may result from recent tremors across the financial sector, according to analysts.
“The dollar continues to trade on a soft footing partly due to the Fed’s anticipated policy remix, as credit tightening will substitute for rate hikes,” said Stephen Innes, managing partner at SPI asset Management.
“The ECB is set to remain more hawkish, favoring the upside EURUSD. Banking stress has translated less materially into a tightening of European financial conditions, given the growth in excess bank deposits over the past decade and the fundamentally improved shape of the European banking sector,” Innes added.
This post was originally published on Market Watch
