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Currency Movements Highlight Monetary Policy Divergence

eurodollarpound janu13 23jan23 lt

Currency movements during the week spanning January 16 to 23 brought to the fore the wide divergence between monetary policy approaches pursued by major central banks.

While the steady decline in inflation provided the Fed with ammunition to taper the rate hikes, it appeared to be hesitant and slow in obliging with a quick dovish pivot. The European Central Bank in the meanwhile reiterated its allegiance to the goal of fighting inflation, amidst warnings of significant rate hikes at a steady pace. The Bank of Japan on the contrary, persisted with its ultra-easy monetary policy stance, despite widespread expectations to the contrary.

Increasing expectations that the Fed would soon tone down its harsh monetary policy strategy, dragged down the Dollar against major currencies in the past week. Hawkish comments by Federal Reserve officials could not suffice to shore up sentiment in favor of the greenback. The Dollar Index (DXY), a measure of the Dollar's strength against major currencies viz Euro, British Pound, Japanese Yen, Canadian Dollar, Swedish Krona and Swiss Franc weakened to 102.01 by January 20, from 102.20 at the end of the previous week. The DXY ranged between a high of 102.90 and a seven-month low of 101.53 during the past week.

The Euro benefitted from the European Central Bank's continuing aggressive monetary policy stance as well as comments by its officials. The European Central Bank President Christine Lagarde affirmed in Davos that inflation in the region continued to be far too elevated, and that policymakers would not let up in their efforts to return price growth to the targeted level. The Euro strengthened from the $1.0828 on January 13 to $1.0855 by January 20. The EUR/USD pair touched a high of 1.0889 and a low of 1.0766 during the past week.

The pound's strength in the past week too was attributed to the fears surrounding the rate hike by the Bank of England in the ensuing meeting. Data released during the week had shown unemployment steady at 3.7 percent, reinforcing the strength of the job market that warranted strong action by the Bank of England to quell price pressures. The British pound which touched a weekly-low of $1.2169 on Tuesday strengthened to touch the weekly-high of $1.2437 by Wednesday. During the past week, the GBP/USD pair increased to 1.2393, from the level of 1.2226 at the end of the previous week.

In the past week, the USD/JPY pair oscillated between 127.22 and 131.59. The yen, which had strengthened amidst widespread expectations of a hawkish tilt by the Bank of Japan, plunged after it came to be known that the central bank had not moved to expand its yield curve control or shift from its ultra-dovish monetary policy stance. The disappointment caused the yen to weaken against major currencies, pushing up the USD/JPY pair to 129.57, from 127.88 a week earlier.

The PCE-based inflation readings from the U.S. are due on Friday, and markets are waiting to see whether the Fed's preferred inflation gauge corroborates the declining trend on display in the CPI. The Fed would hand over its next interest rate decision on the first of February while the Bank of England and the European Central Bank would follow a day later. Based on the monetary policy expectations already priced in, the Dollar Index (DXY) is currently at 102.16. The EUR/USD pair is at 1.0852, the GBP/USD pair at 1.2337, and the USD/JPY pair at 130.63.

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