We announced a week ago that due to the meetings of the most important central banks, volatility can be expected. The currency markets did not disappoint. The biggest loser turned out to be the dollar following the dovish pivot of the Federal Reserve, which ended the week at the bottom of the G10 range. The Fed’s pivot also contributed to the fall of the EUR/PLN pair to levels unseen for nearly four years.
This shift was visible both in the bank’s rhetoric and in forecasts of interest rate levels in the dot plot. The European Central Bank and the Bank of England adopted a diametrically opposing hawkish position, and despite recent rather pessimistic news from Europe, market expectations for rate cuts were pushed back. The Fed’s messages pleased financial markets – stock and bond prices rose, and nearly all currencies strengthened against the dollar.
The holiday period is approaching, which means low activity in the markets. Meetings of the main central banks are already behind us, and there will also not be a lot of macroeconomic data capable of moving markets. The most important will be further messages from decision-makers.
For the first time in a long time, the Fed and European policymakers are presenting significantly different positions in the context of future monetary policy. This seems somewhat perplexing given that they contradict what macroeconomic readings suggest on both sides of the Atlantic. While the U.S. economy continues to grow, the eurozone appears to be contracting again. This week we will get inflation reports from the UK (Wednesday 20.12) and the US (Thursday 21.12), which may help clarify this intriguing contrast.
The EUR/PLN pair fell last week to its lowest level since March 2020 (4.29), due to the Fed’s dovish pivot in communication. However, the zloty gave back some of its gains in the following days and eventually ended the week at nearly the same level against the euro. News from across the ocean is certainly positive for the prospects of the Polish currency, but as is often the case, markets seem to react too violently to signals from decision-makers. Moreover, expectations for NBP interest rate cuts have also risen, which should limit the impact of the Fed’s change in rhetoric on the Polish currency.
In the context of domestic news, it is worth mentioning that data on the current account balance surprised on the upside last week, indicating a surplus of around 2 billion EUR in October, which is positive news for the zloty. There was also a slight upward revision of November inflation (from 6.5% to 6.6%), but its prospects seem to be improving – both the strength of the zloty and general improvement in foreign surroundings relevant to inflation are contributing factors. In this context, it is also worth mentioning that there was a significant drop in the core measure (from 8% to 7.3%), which today’s data confirmed.
The European Central Bank maintained its stance last week – president Christine Lagarde stated it was not yet time to let down guard, and policymakers did not even discuss the possibility of lowering interest rates. These hawkish messages did not come at the best time. The day after, December PMI business activity indicators were significantly worse than expected, following the widespread slowdown in Germany and France. Readings well below the 50-point barrier seem to confirm that the euro area is experiencing technical recession in the second half of the year.
The dollar is being pulled by two opposite forces: the clearly dovish turn of the Federal Reserve and the undeniable strength of the US economy. The former was underscored by last week’s dot plot – a chart showing the expected trajectory of interest rates by Federal Reserve policymakers. It currently points to three cuts in 2024 (compared to one in the September forecast). The latter was confirmed by a series of secondary readings such as retail sales and weekly jobless claims.
The Bank of England gave us a hawkish surprise last week. Just like in November, three of the nine Board members voted for raising interest rates, without any change in the forward guidance – the bank is prepared for further increases in interest rates if inflation turns out to be “persistent”. It therefore stands in clear contradiction with the market pricing of cuts. This resulted in a sharp appreciation of the pound, which on Friday was further supported by surprisingly good PMI indicators suggesting that the UK economy is accelerating towards the end of the year. A substantial improvement in the services index suggests that the British economy is growing again and, unlike the eurozone, will avoid a recession. The hawkish stance of the central bank and the improving sentiment should provide solid support for the pound in the coming weeks.
Authors: Enrique Diaz-Alvarez, Matthew Ryan, Roman Ziruk, Itsaso Apezteguia, Michał Jóźwiak – Ebury analysts.
