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We have already witnessed a divergence in monetary policy. While the Fed has already reduced its monetary stimulus, the ECB and the BOJ seems more dovish in their approach. The ECB is ready to consider additional monetary policy measures.

Thus the divergence in monetary policy among the developed economies is likely to play a critical role in future trend and further price actions in the currency markets, which currently seems USD Bullish.

Guest post by Rajesh Mishra

Now the ball is in other central bank’s court to decide how to deal with further price actions. A stronger Euro has always been detrimental to the Euro zone economy, which is export driven. While a stronger US Dollar against the Euro might limit the recent Euro uptrend, particularly post the FED tapering, expectation of sustainable economic recovery particularly in the US is likely to increase the risk appetite thereby supporting risk currencies such as the Euro. Under this scenario, the earlier statement of the ECB president to do whatever is needed to support Eurozone economy and to protect the Euro seems significant. Now, a monetary policy action looks imminent, given the ECB has reiterated its stand to consider even negative interest rate. A possibility of another trench of further LTRO cannot be ruled out after a clear idea of the strength of the bank’s balance sheet after the stress test.

The BOJ has been left on its own, because the Yen is most vulnerable after the FED’ tapering and it might test a level of 105 versus the US Dollar. The nation’s trade deficit has already widened to 1.35 trillion Yen in November which will have tremendous effect on the Yen given the introduction of national sales tax in April. Therefore, The Bank of Japan will have significant scope to expand its monetary base by increasing its purchases of 7 trillion Yen (US$75 billion) worth of long-dated Japanese government bonds (JGBs) every month.

In the UK, the Bank of England has pledged to keep the interest rate low until the unemployment rate falls to 7% with an inflation target of 2%. With October figure of 7.4 % unemployment rate, the BOE is likely to raise interest rate sooner than expected.