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FX Viewpoint: EUR and GBP: Modest downside ahead

26 Feb 2024

Key takeaways

  • The ECB and BoE are likely to pivot more explicitly towards policy easing in the months ahead

  • Rate cut cycles, unsurprisingly, tend to be modestly negative for the EUR and GBP…

  • …but the degree of FX weakness depends on the nature of rate cuts and the external environment

The ECB and BoE are likely to be more explicit about policy easing in the months ahead

With the European Central Bank (ECB) and the Bank of England (BoE) likely to pivot towards a rate-cut stance in the months ahead, we take a brief look at how past rate-cut cycles by both central banks have affected their currencies. We consider cycles since the late 1990s (coinciding with the ECB’s formation and BoE’s independence), and do not include one-off rate cuts.

We have three key takeaways:
  1. Rate-cut cycles tend to be FX negative: This is not a surprising finding. On average, EUR-USD dropped 5.2% during these cycles, and GBP-USD dropped even more than EUR-USD. However, these average FX performances were dragged down significantly by the moves in the 2008-09 global financial crisis.

  2. Idiosyncratic rate cuts have the biggest negative impact: The EUR fell aggressively during the mid-2010s cycles, driven by a mix of weak local economic dynamics and sovereign debt concerns.

  3. External environment matters: The EUR and GBP could hold up a bit better when either the Federal Reserve (Fed) is cutting more and faster, or global equities are rising – providing a ‘risk on’ lift.

Note: *Rate cuts denominated in basis point from peak to trough; FX performance from the day of first cut to the day of last cut; N/A indicates BoE and Fed did not cut in these cycles. Source: Bloomberg, HSBC

In the rate-cut cycles in 2024, we see modest downside risks for the EUR and GBP

Within this context, we expect the start of the rate-cut cycles in 2024 to be mildly negative for both EUR and GBP, even if markets have currently priced in rate cuts, as they had been in previous cycles. Our economists expect the first rate cut from the Fed and the ECB in June, while August is more likely for the BoE. Neither the ECB nor the BoE is likely to deliver idiosyncratic rate cuts, but both could end up with a more dovish cycle than the Fed, weighing on their currencies. At the same time, the global economy is expected to slow this year, so risk sentiment is unlikely to improve significantly. As such, support for both currencies is set to be limited. The EUR and GBP are also still stronger than what their rate dynamics imply. Given the circumstances, we expect both the EUR and GBP to weaken modestly against the USD in 2024.

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