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The dollar looks set to extend its multi-week appreciation trend against the pound and euro amid gloomy market sentiment linked to the war in Ukraine and news that US inflationary pressure has eased. enlarged.
Markets now expect up to 160 basis points of Federal Reserve hikes in 2022 after the US announced that core inflation hit 6.4% year-on-year in February, ahead of estimates of 5.9%.
CPI inflation met analysts’ expectations after rising to 7.9% year-on-year in February from 7.5% in January.
“The Fed must act quickly to contain mounting price pressures,” said economist Katherine Judge of CIBC Capital Markets.
Above: A 40-year high for inflation. Graphic: UniCredit.
The Fed is expected to make more rate hikes in 2022 than the Bank of England, European Central Bank and all other G10 central banks except the Reserve Bank of New Zealand.
This is proving a source of support for the dollar.
The Pound to Dollar exchange rate is 0.40% lower at the time of writing at 1.3131 while the Euro to Dollar exchange rate is down two thirds of a percent to 1.1008.
“Price rises were again broad-based, but were led by petrol, food and housing,” said Daniel Vernazza, chief international economist at UniCredit Bank in London.
Russia’s invasion of Ukraine has meanwhile led to a sharp rise in commodity prices, especially energy, suggesting that additional inflationary prices will develop.
“Rising crude oil prices mean gasoline prices will rise in March, likely pushing the headline 12-month rate over 8%. This should mark the peak as negative base effects start to pull down the 12-month rate, but the uncertainty is very high,” says Vernazza.
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Inflation data boosted an already bearish stock market, which generally favors the safe-haven and highly liquid US dollar.
“It looks like yesterday’s bounce might have been a bit of a one-hit wonder, a product of short cover and thinner liquidity. Nothing in the last 24 hours really suggests a major change in tone. , and for now the bearish scenario continues to prevail, bolstered by lingering fears over inflation and the shift towards hawkish central bank policy,” said Chris Beauchamp, chief market analyst at IG.
Equity markets rose in 2020 and 2021, boosted by the abundant liquidity provided to the global financial system by the Federal Reserve’s ultra-low interest rates and quantitative easing.
The offer of “easy money” has not ended, however, and markets are adjusting lower.
The implied scarcity of dollars that such a squeeze presents is in itself likely to be a compelling driver of dollar demand.
Above: USD outperformed in 2022, with only AUD and NZD adding more value.
The countercyclical dollar, however, would likely change direction and head lower as global growth picks up and the US economic outperformance begins to look less exceptional.
That seems unlikely to happen anytime soon, especially with few signs of a peaceful conclusion to the conflict in Ukraine.
Analysts had taken up various comments from Ukrainian and Russian officials at various times this week as evidence that there was room for a negotiated settlement.
The sharp rise in stocks during the mid-week session, which also saw the euro and the pound appreciate against the dollar, was partly attributed to these hints that a negotiated settlement was possible.
But Russian and Ukrainian negotiators wrapped up talks in Turkey on Thursday with no progress made, a chilling reminder to investors that these are incredibly difficult markets to navigate.
Moscow and Ukraine are entrenched in their positions, the war continues and meanwhile inflation escalates, leaving central banks no choice but to turn off the liquidity taps.
These are favorable conditions for further pound-dollar weakness.