Optimistic central banks

Sep 23, 2020
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After attempting to break through the 1.2000 bar against the dollar, the euro has returned...

After attempting to break through the 1.2000 bar against the dollar, the euro has returned to the bottom of the 1.1650–1.2000 range it has remained in since mid-July. The two main central banks have expressed some optimism in recent weeks. First off, the European Central Bank revised its economic forecasts for this year upward. It now expects eurozone GDP to fall by 8%, an improvement from -8.7% growth previously. The recovery will be less pronounced next year, however, with 5% growth instead of 5.2%. While these forecasts may change depending on how the pandemic evolves, for the moment they mean monetary policy is staying as it is. The cash injection via the Pandemic Emergency Purchase Programme (PEPP) will continue. Christine Lagarde, however, noted that weak demand, pressure on wages and the rise of the euro are helping to keep inflation well below expectations. The ECB is forecasting an inflation rate of 0.3% at the end of this year, 1% next year and 1.3% in 2022 – still far from its 2% target. Although Ms Lagarde has pointed out that exchange-rate developments are not part of the ECB’s duties, she recognised its impact on inflation. Her statement echoed that of Philip Lane, ECB Chief Economist, who earlier this month declared “euro-dollar rate does matter”. The remark had broken the momentum of the single currency, with investors fearing ECB actions to mitigate the rise.

Last week at its monetary-policy meeting, the US Federal Reserve declared, too, that the country’s economy is expected to do a little better than expected in 2020, even if a return to the situation at the beginning of the year remains distant. The recession will be weaker than expected, and the labour market will recover faster than expected. GDP is expected to decline by around 3.7%, against 6.5% estimated in June. The institution is also forecasting 7.6% unemployment, down from 9.3% in its latest forecast. The Fed also raised its inflation forecast and is expecting 1.26% for 2020 compared to 0.8% previously. It believes she can achieve its 2% goal in 2023. Therefore, interest rates should remain in the current 0-0.25% range until at least 2023. Just like the ECB, the Fed has stated that the economic recovery will depend heavily on how the pandemic evolves.

The Bank of England left its policy rate unchanged at 0.10% last Thursday. It is expecting GDP to shrink by 7% this year compared with 2019 and has announced the possibility of introducing negative rates. The Bank of Australia is also considering negative rates. Deputy Governor Guy Debelle said the bank is considering four options to help the Australian economy. The first would be to buy longer-term bonds to lower long rates. The second option concerns the exchange rate at which the central bank could intervene in order to prevent the Australian currency from appreciating. The third possibility would lead the Bank to lower its rates close to 0% and finally the fourth to consider introducing negative rates. These comments weighed on the Australian currency, which is at its lowest rate in six weeks against the greenback.

The Turkish lira is declining against the dollar for the eighth consecutive day at ₺7.6821 to the dollar. It is a new historic low. Such devaluation is putting additional pressure on the Bank of Turkey, which could raise its base rate tomorrow, even if President Erdogan would like it to reduce them in order to revive the economy. Even at the beginning of the year, Turkey’s currency was worth less than ₺6 for a dollar at the beginning of the year.

Gold has fallen back in recent days in the wake of the equity-market correction and the rise of the greenback, with investors initially seeking to liquidate their winning positions for profit-taking. For this reason, the yellow metal was penalised because of its soaring rise recorded since July.

Central banks and prospects for a post-crisis world are dominating the current news, but the upcoming deadlines, such as the US election, Brexit, or the US-China trade talks, can change the game at any time.