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Analytics, 06 May 2022

Currencies reaction to latest interest rate hikes

Higher interest rates tend to increase the value of the country’s currency relative to other nations with lower interest rates. It is not surprising that major currencies, including the US dollar, have been experiencing swings every time central banks announce their intent to increase interest rates.

But often it doesn’t occur in a straight line when it comes to foreign exchange transactions since other factors impact currency value and exchange rates; these include the relationship between higher interest rates and inflation.

Central banks have raised interest rates in response to rising inflation since a rapidly rising inflation can devalue a nation’s money quicker than interest rates can compensate savers.

In recent times, increases in the Federal Reserve funds rate have attracted investment capital from foreign investors seeking higher returns on bonds and interest-rate products, resulting in a stronger US dollar.

How major currencies reacted to latest interest rate hikes

After hitting a new 20-year high, the dollar index pared gains as traders weighed a recent global market sell-off stoked by recession fears. The dollar index, which tracks its performance against a basket of six major rivals, gained as much as 0.5% in early European trading hours to hit a fresh 20-year high of 104.07. The U.S. currency gained on expectations the Federal Reserve will tighten monetary policy faster than peers in response to rising inflation. Still, it lost some ground, and was last down 0.5% at 103.24. The index appeared close to record a fifth straight week of gains, up 0.3% on the week.

The rise followed the Feds decision to raise interest rates by half a percentage point – its biggest increase in 22 years. The Federal Reserve hiked interest rates by 50 basis points, moving them into the 0.75%-1% range, while predicting additional ones and emphasising that the Russia-Ukraine crisis continues to pose upside risks to inflation. But the dollar dropped after the Fed announced that no interest rates are anticipated in the near future.

Meanwhile, other currencies lost as much against the dollar. For example, before reversing course, the euro lost as much as 0.5% against the dollar in early European trading hours. It was last up 0.5% at $1.059. Sterling traded at $1.2362, just a day after the Bank of England warned of a recession, in addition to raising interest rates by a quarter of a percentage point to 1%.

How did Asian currencies react?

Asian currencies, notably the yen, gained slightly against the dollar, up 0.1% to 130.30 yen per dollar. Meanwhile, the Chinese yuan once again fell against the dollar, as the market speculated a possible easing of monetary policy by the People’s Bank of China.

How will the dollar perform this year?

The current state of the market has been beneficial for the US dollar. The US dollar index remains at a 20-year high. Since 2022 started, the index has risen almost 8 percent, and more than 13 percent in the last 12 months. Comparably, the stable Japanese yen, has fallen 13 percent below the dollar this year alone. The US Federal Reserve’s latest monetary decisions will continue benefiting the dollar. While rising rates will likely be volatile for stocks, bonds, and mortgage rates, they are likely to aid the dollar.

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