The euro/dollar will only slip into a 1.05-1.10 trading range and no lower. 

Expectations about monetary policy in the major countries certainly appear to be driving short-term currency dynamics. The likes of the Fed, ECB, and BoE are all becoming more hawkish in their outlooks given the persistence of high inflation. And, as each central bank, in turn, moves the monetary dial up another notch, the value of its currency gets a lift. But while all this creates an interesting focus for the market, the truth is that the world is gripped by a surge in inflation and it seems very likely that central banks will act in similar ways to combat it. Hence, the scope for policy divergence actually seems quite limit ed, and the corollary of this is that currency movement is likely to be limit ed as well. Of course, there are some exceptions. China’s strict COVID policy and underlying structural frailties are helping to keep inflation low and the PBOC focused on easing policy. In addition, countries with a long history of deflationary pressure, like Japan and Switzerland, have also seen limit ed upward pressure on prices, and policy expectations have remained quite stable as a result. But, for most others, rate hikes and an unwinding of QE are the way ahead, and we think that limit s the scope for significant currency divergence.

To put some numbers on this, Mr. Steve Barrow still expects the dollar to strengthen modestly in coming months as he feels that the Fed has the most to do to get on top of price pressures. But with the ECB not so far behind, he still thinks that the euro/dollar will only slip into a 1.05-1.10 trading range and no lower. What’s more, once currency markets become accustomed to tighter policy and look ahead to more modest price pressure and economic improvement as COVID slowly departs, the dollar should slide again and we still target the euro rising to 1.30-1.40 in coming years.

Monetary policy is not going to be the only focus. Geopolitical strains associated with tensions at the Russia/Ukraine border will likely maintain a bid for the low inflation ‘safe’ currencies such as the yen and the Swiss franc. Hence these currencies won’t crumble as the lack of rate hikes might seem to suggest. And, as for the renminbi, rate differentials are clearly not undermining the currency and, in Mr. Steve Barrow’s view, unlikely to do so. Instead, he feels that international fixed income investors could continue to be drawn to the Chinese market given that yields seem unlikely to rise in the same way as he is seeing elsewhere. The stock market could also remain something of a draw. Hence, here he thinks that any near-term dollar strength will be constrained to the 6.50 region and, in time he looks for a move to the 5.50 area for dollar/renminbi.

Politics is another factor that could have at least a short-term bearing on currencies. The current pressure on UK PM Johnson over the alleged ‘Partygate’ affair, whereby a number of ‘illegal’ parties were said to have taken place in Number 10 Downing Street during lockdown, could come to a head very soon. So far, the prospect of Johnson being ousted as Conservative leader and PM has not ruffled the pound noticeably. Whether that’s because the market is assuming any plot to oust him will fail, or that it does not really matter who is the leader, is difficult to say. "We’d suggest that it is more a case of the latter, although we don’t doubt that a bit of short-term weakness could creep into the pound should Johnson be toppled," Mr. Steve Barrow said.

"All told, our currency outlook remains one of rising volatility and some modest short-term dollar strength, which we do not expect to persist over the long haul. Political tensions in the UK could help pull the pound towards our 1.25-1.30 target range, but, just like the euro/dollar, we see recovery over the long haul via a rally to the 1.50-1.60 range", Mr. Steve Barrow stressed.