The recent behavior of the euro and the British pound and their potential weakness against the rest of the world's major currencies is beginning to bring concerns about a sustained deterioration in the prospects for these currencies.
As Bloomberg commentators note, the behavior of the pound and the euro are worrisome. We have recently seen large shifts in the euro and pound's short-term market interest rates against the U.S. dollar, with a simultaneous weakening of the GBP/USD and EUR/USD exchange rates. Last week was the worst week for the pound in nearly two years, and at the same time, the yield on the UK's 2-year bond rose by 50 basis points. Typically, the opposite happens in developed markets.
Expectations of a central bank rate hike and thus an increase in short-term market yields generally strengthen the currency. The collapse in the correlation between the exchange rate and interest rates is usually associated with emerging markets, which may have lost the battle for the credibility of keeping inflation within the inflation target. The energy dependence of the UK and Europe as a whole means that their balance sheets could deteriorate in the near future, while energy commodity inflation shows no signs of abating. Rate hikes in such a situation may not stem the tide of depreciation of the aforementioned currencies, Bloomberg reports.
Thus, it seems that the winter months for the 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 the EUR and GBP despite rising interest rates could be potentially worrying. Moreover, it could change the entire scene of the foreign exchange market. In the dollar index, the euro has a weighting of more than 57 percent, while the pound has a weighting of more than 11 percent. Together, these two currencies alone have a weighting of almost 70 percent.
Since the beginning of the year, the euro against the U.S. dollar has lost almost 12 percent, and the British pound almost 13 percent. In contrast, since August 2021, the euro has lost almost 15 percent to the dollar, and the British pound less than 14 percent. Of the major currencies, only the Japanese yen has fared worse and has weakened by almost 20 percent against the U.S. dollar over the year.
Daniel Kostecki, Director of the Polish branch of Conotoxia Ltd. (Conotoxia investment service)
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