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Pound and euro similar to emerging market currencies?

Pound and euro similar to emerging market currencies?

created Daniel KosteckiAugust 22 2022

Euro and British pound prices and their potential weakness raise concerns about a permanent deterioration in the outlook for these currencies. As noted by Bloomberg commentators, the behavior of the pound and the euro is worrying. We have recently seen large movements in the short-term market interest rates of the euro and pound against the US dollar with a weakening in the exchange rate. GBP / USD i EUR / USD. The past week was the worst for the pound in almost two years, and at the same time the yield of 2-year UK bonds increased by 50 basis points. Usually the opposite is true in developed markets.

Interest rate increases are unimpressive

Expectations for an increase in the central bank's interest rates and thus an increase in the profitability of short-term market rates usually strengthen the currency. The breakdown in the correlation between the exchange rate and interest rates is usually associated with emerging markets, which may have lost the fight for the credibility of keeping inflation under the inflation target.

The energy dependence of the UK and Europe as a whole means that their balance sheets may deteriorate in the near future, and inflation in the energy market shows no signs of weakening. In such a situation, interest rate hikes may not stop the wave of depreciation of the aforementioned currencies, he says Bloomberg.

A permanent change on the currency scene? 

The winter months for EUR and GBP may be a kind of test of the credibility of the economies in the eyes of investors. Their abandonment of investments in EUR and GBP despite rising interest rates could be a potentially worrying phenomenon. Moreover, it could change the entire FX market scene. In the dollar index, the euro weighs over 57%, and the pound over 11%. Together, only these two currencies weigh almost 70 percent.

Since the beginning of the year, the euro has lost almost 12% against the US dollar, and the British pound around 13%. In turn, since August 2021, the euro has lost almost 15% against the dollar, and the British pound less than 14%. Of the major currencies, only the Japanese yen underperformed and depreciated by nearly 20%. against USD per annum.

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About the Author
Daniel Kostecki
Chief Analyst of CMC Markets Polska. Privately on the capital market since 2007, and on the Forex market since 2010.

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