Europe’s currencies feel fresh pain as central bank support fades

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 a more than six-month low against the dollar on Thursday, even after the Bank of England 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 versus the dollar, fell almost 1% at one point after Switzerland surprised markets by pausing its rate rise cycle.

Meanwhile, Thursday’s quarter-point rate rise in Sweden failed to provide much respite for the battered Scandinavian currency, which is down over 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 (EPA:SOGN).

SOUNDING HAWKISH

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

The European Central Bank 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.

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

The ECB, like the U.S. Federal Reserve, has pushed the idea of rates staying higher for longer. This 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 (LON:AV) Investors. But markets, he said, were “getting ahead of this.”

Sweden’s Riksbank raised its key rate by 25 bps to 4% and said it may need to do more to bring inflation lower. The currency, which the central bank labeled “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.

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

{{2126|The dodollar index which measures the U.S. currency against peers, is near its highest in over six months.

This, said Manulife Investment Management chief investment officer Nathan Thooft, is because “the data suggests the U.S. economy right now is much better than much of Western Europe.”

He expected one the of big European central banks to be the first to cut rates.

Economists polled by Reuters expect the euro zone economy to grow 0.6% this year, the UK to expand 0.4% and the United States by 2%.

“As we become more data dependent, currencies swing around with every bit of data that’s available,” said Bjoern Jesch, global chief investment officer 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, trading near 10-month highs above $90 a barrel.

“The U.S. 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 (LON:BARC) 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.

This made 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 going forward and this in itself will create higher market volatility,” she said.

Europe’s currencies feel fresh pain as central bank support fades