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Much has been made of the economic implications of today’s anticipated ECB interest rate increase, not least the fact that it’s likely to make matters worse for the periphery, rather than better.   Nevertheless, there are two reasons why at least in the short-term, it’s of significance for FX.

Guest post by FXPro

Firstly, the ECB is moving ahead of the Fed, which is a first as, throughout its twelve year history of setting rates for the eurozone, it has invariably lagged the Fed in both tightening and easing cycles.   This is the primary reason why the euro performed so well during the first quarter, despite the disappointing news on the underlying credit crisis and the EU’s attempts to resolve it.

 

Secondly, it’s the fact that interest rates differentials are widening.   This has already happened, given the substantial widening of market interest rates that have been seen as markets have factored in the expected ECB tightening.   If we look at Australia, where the tightening cycle started in October 2009, the Aussie dollar has appreciated some 25% vs. the USD over that time.   For the moment at least, there are few reasons to think that the ECB is poised for the beginning of a tightening cycle of a similar magnitude.   There are several unique reasons why Australia has managed to pull away, not least the fact that it was far less affected by the financial crisis and also it has benefitted from the rise in commodity prices and its integration with the faster growing Asian nations.

 

Australia is the more extreme example of the fact that diverse economies (or areas) have been affected to different degrees by the events of recent years. Some are emerging pretty much unscathed, whilst others are only part way down the process of repair.   This is fair normal during recessions and more so for recessions caused by credit bubbles.   This suggests we are only part-way down the road of seeing greater volatility and greater divergence in currency values globally.


Simon Smith, Chief Economist


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