Europe’s currencies feel more pain as rate cuts loom

There’s no respite for struggling European currencies as a likely pause in central bank interest-rate rises and a weakening economic outlook puts the focus on prospective rate cuts ahead.

Sterling slid to the weakest level in more than six-month low against the dollar on Thursday, even after the Bank of England (BOE) held rates at a 15-year high and pledged to raise borrowing costs again if it cannot tame inflation.

The Swiss franc, one of this year’s best-performing major currencies against the dollar, fell almost 1% at one point after Switzerland surprised markets by pausing its rate rise cycle.

Also, Thursday’s quarter-point rate rise in Sweden failed to provide much respite for the battered krona, which has weakened more than 6% against the greenback so far this year.

In short, the outlook for currencies in Europe is bearish, analysts and investors say, citing a strengthening dollar and stagnant economic growth in European nations as oil prices rise.

“We are turning to a bigger focus on growth than what central banks do,” said Kit Juckes, global head of currency strategy at Societe Generale.

Sounding hawkish

The BOE offered mixed messages by pledging to stay tough on inflation, which is still more than triple its 2% target, while noting that economic growth was slowing.

The European Central Bank (ECB) last week lifted rates to a record 4% and upgraded its inflation forecast for 2024, but the euro fell and has lost almost 2% against the dollar this month.

Juckes said the euro was “headed for a look at parity”, in a reference to the $1 marker.

The ECB, like the US Federal Reserve, has pushed the idea of rates staying higher for longer. That backdrop should support a currency, but in the euro’s case traders are homing in on the region’s economic underperformance and betting the ECB will be forced to cut before the Fed.

Overall, Europe’s central banks “would like to portray this idea of higher for longer [rates],” said Ed Hutchings, head of rates at Aviva Investors. But markets, he said, were “getting ahead of this”.

Sweden’s Riksbank raised its benchmark rate by 25 basis points to 4% and said it may need to do more to bring inflation lower. The currency, which the central bank labelled “unjustifiably weak”, barely caught a break and remains near a record low against the euro.

Sweden’s economy, hurt by turmoil in the real estate market, is expected to contract this year.

The only central bank whose hawkish tones have struck a chord with markets is the Fed, which on Wednesday held rates steady but signalled one more rate rise this year.

The dollar index which measures the US currency against six peers, is near its highest in more than six months.

That, said Manulife Investment Management CIO Nathan Thooft, is because “the data suggests the US economy right now is much better than much of Western Europe”.

Thooft expects one the of big European central banks to be the first to cut rates.

Economists polled by Reuters expect the eurozone economy to grow 0.6% this year, the UK 0.4% and the US 2%.

“As we become more data dependent, currencies swing around with every bit of data that’s available,” said Bjoern Jesch, global CIO at DWS Group.

The push and pull in market expectations ahead of rate decisions, as has been the case in Britain and the euro area this month, highlights rising volatility around central bank meetings.

Nomura expects sterling to weaken to $1.22 by end-October, from $1.23 now; ING economists said the Swedish crown remained “vulnerable”.

Volatility

Another driver of dollar strength is oil prices, which are trading near 10-month highs above $90 a barrel.

“The US is an oil producer so it tends to get hurt very little by higher oil prices whereas Europe and Japan get hit more,” said Barclays global head of FX strategy Themos Fiotakis.

European central banks were “in a bind”, Fiotakis added, as higher oil prices also threatened to push inflation higher.

That makes rate cuts bets in Europe seem vulnerable, said Orla Garvey, senior fixed income portfolio manager at Federated Hermes.

“Growth and inflation data will be more volatile and this in itself will create higher market volatility,” she said.

Reuters