Hawkish tone from central bankers at ECB Forum provides support for the USD

The heads of the US Federal Reserve, European Central Bank and the Bank of England all warned this week that more action would be needed to combat inflation, continuing the hawkish tone we have heard over the last few weeks.

In the immediate aftermath of the speeches at the Forum, the USD Index (DXY) surged. The EUR/USD and GBP/USD were hit particularly hard, with the former falling below 1.0900 before recovering. The GBP/USD fell over 100 pips before settling around 1.2640.

At the ECB Forum on Central Banking in Sintra, Portugal, all three Central Bank heads were unequivocal on the need for further monetary tightening. Jay Powell, Chairman of the US Federal Reserve, said:

“Although policy is restrictive, it may not be restrictive enough and it has not been restrictive for long enough… I wouldn’t take moving at consecutive meetings off the table at all. We need to see a better alignment of supply and demand in the labor market and see some more softening in labor market conditions so that inflationary pressures in that sector can also begin to subside”.

Powell also reminded his audience that he expects the FOMC to raise rates at least two more times this year, though this view is not shared by the market, exposing a long-running rift between investors and the Fed.

Echoing his comments, Christine Lagarde, President of the European Central Bank, said: “We’re not seeing enough tangible evidence of underlying inflation — particularly domestic prices — stabilising and moving down.” It’s clear at this point that markets are concerned with the ECB’s continued hawkish tone, with inflation falling rapidly across the eurozone and domestic markets beginning to show signs of stress with rising unemployment and lower consumption. Analysts are particularly concerned about the prospect of a recession in Germany.

For his part, the Bank of England Governor, Andrew Bailey, warned that core inflation in the UK — excluding energy and food — was “much stickier” than headline inflation. He noted that the UK’s tight labour market could force continued high wage growth, which could keep price pressures elevated. His comments failed to support the GBP, with the market bearish on the UK economy’s chances of avoiding a recession.

Elsewhere, a surprise fall in US stockpiles provided support to crude oil prices, and the USD/JPY climbed to its highest level since November on Thursday morning, peaking at 144.70 before profit-taking forced a 50 pip drop in a matter of minutes.

Friday brings a host of events in the economic calendar, with eurozone core inflation and German unemployment figures due in the morning session before PCE Price Index data is released in the US. If the eurozone data shows a continued fall in inflation, this would only provide further support for the USD, especially if the PCE Price Index comes in as forecast.