The pandemic has continuously impacted the foreign exchange (forex) market. Economies across the globe have been significantly weakened due to ongoing lockdowns and restricted travel.
Then, in the midst of economic recovery, and signs of hope amongst investors and consumers, another variant of COVID-10 emerged, bringing volatility to the market once again.
December also marks a big month for investors, as there’s plenty of central bank action to focus on. On the week commencing December 13th, the US Federal Reserve (Fed), the Bank of England (BoE) and the European Central Bank (ECB) were all due to announce their monetary policy decisions.
In this article, we will explore the various factors that can affect the forex market, and in particular, the euro (EUR).
Inflation rate for the eurozone
According to Plus500 forex trading:
“Macroeconomic data is the most important and heavily relied upon information when it comes to forex trading. This is because it is the data which is most pertinent when it comes to the strength of an economy.”
This data includes interest rates — as the rate for one country compared to another can determine exchange rates — and inflation rate, which can be determined by the indicators, Consumer Price Index (CPI) and Producer Price Index (PPI).
The two have a close relationship, as a change in inflation rate can influence the decisions made by central banks concerning interest rates.
When it comes to the present value of the euro, this has been deeply affected by the rate of inflation. Across Europe, inflation rates are high in response to the pandemic, and then the reopening of the global economy. It reached a record-breaking 4.9% in recent months — a high never seen before by the eurozone.
This has also been driven by labour shortages in certain industries, paired with bottlenecks and other issues in the supply chain. Energy prices have also soared in Europe, with a sharp rise by nearly 28% in November 2021, compared to the year before.
Inflation is a topic investors and economists predicted the ECB would discuss in their December meeting, and alter the interest rates accordingly. However, it’s believed that policymakers will continue to insist this level of inflation is temporary.
Inflation can be detrimental to an economy if it is too high or too low, therefore the ECB consistently aims to keep annual inflation at 2%. However, they have not yet raised interest rates to balance the effects of high inflation, believing that inflation will ease in time.
With uncertainty and the unpredictable nature of the ECB decisions, the forex market has experienced volatility in terms of the euro. Investors that may have predicted the ECB to act hawkish, could have been proven wrong, with market sentiment surrounding the event also impacting the currency.
In November 2021, the World Health Organisation (WHO) deemed the Omicron variant of the coronavirus, a variant of concern — meaning its behaviour and mutations could impact how easily its spread and the severity of the symptoms it causes.
The correlation between the virus and economic performance has varied significantly between nations, which is a stark difference between the uniform approach that the central banks had taken at the beginning of the health crisis back in 2020.
As the central banks of different countries respond in contrast to each other, in terms of interest rates, this could impact the exchange rate between the two currencies. For example, if the BoE have higher or lower rates than the ECB, this would impact both the euro and pound, and their relative currency pair.
If the central bank were to increase interest rates, this would attract foreign investors and capital, meaning the exchange rate would also rise. Forex traders therefore will be monitoring closely the impact of the Omicron variant, as well as Europe’s inflation rates, as these factors may mitigate the effects of higher interest rates, and cause the value of the euro to drop.