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The cloudy market mood due to fresh western sanctions against Russia and atrocities against Ukrainian civilians has hurt the risk-sensitive pound. Adding to this is the policy divergence between the Bank of England and Federal Reserve, as the latter remains more hawkish and determined to tighten monetary policy. For those exchanging pounds to US dollars or vice versa, the key event will be the Fed minutes released later today at 7pm BST.
The pound weakened since yesterday, despite starting the new week on a positive note, as investors’ confidence was hurt following rising tensions in the Russia – Ukraine conflict, reports of war crimes and western sanctions against Kremlin.
Central Bank divergence
Markets are expecting the Federal Reserve to proceed to aggressive tightening, with the potential to announce both a balance sheet reduction and bigger rate increases in the upcoming May meeting.
The divergent monetary policy outlooks between the Fed and the BoE have kept the pound lower against the US dollar. BoE policymakers remain in a difficult position and have avoided pointing to any further rate rises, as they fight surging inflation and risks to economic growth.
Traders will focus on the Fed March meeting minutes for guidance regarding a rate hike in May. Chairman Jerome Powell has said previously that the minutes will contain details of the bank’s plan for quantitative tightening including the size of the targeted monthly balance sheet reduction.
Market participants expect the balance sheet to shrink by $US2½ trillion, but some analysts have noted that the Fed will be less aggressive, and the US dollar could weaken in response.
The US dollar rose against both the euro and the pound after two US policymakers warned that the Federal Reserve could decide as early as next month to begin shrinking its near-$9trillion balance sheet faster than expected.
Ukraine and Eurozone politics
The euro is lower and pressure on the single currency will continue as the Russia – Ukraine conflict and rising political risks ahead of the French elections persist. The upcoming April presidential election in France and uncertainty about the outcome will weight on the euro.
New sanctions against Russia will have a negative impact on both the euro and the pound. Both currencies will also continue to be under pressure as the war in Ukraine rages on and energy supply risks continue too. The imposed sanctions will affect negatively western countries and Europe in particular. The White House said that the US government and its allies will impose new sanctions on Russian banks and officials on Wednesday and ban new investment in Russia. The head of the European Commission also said that there will be further sanctions including examining energy imports on top of those announced on Tuesday.
Headlines regarding news about the war in Ukraine will influence both the euro and the pound and both will also be sensitive later today to the release of the minutes from the March meeting of the Federal Reserve.
Scotiabank and Credit Suisse economists expect the pound to weaken further. As Scotiabank analysts noted, “widening gilts-UST yield differentials have begun to weigh more clearly on the pound in recent trading” and could even go lower. They added that the pound will weaken further as the “gap between year-end hike expectations widens further.”