The flagship currency pair moved in a very narrow range in December, in the order of just 130 pips, which is very little. Usually, there is more volatility in this pair at the end of the year. The difference in monetary policy between the European Central Bank and the US Federal Reserve does not seem to be favouring the dollar in the short term, although this could quickly change. The big question that will come up in the coming weeks and months will be whether the European Central Bank will continue to support the notion that inflationary pressures are temporary, even though all the indications are that they are here to stay. Some members of the Governing Council (particularly the Netherlands' Klaas Knot) suggested last week that the ECB could put an end to its asset purchase programme to combat the pandemic (also known as QE) sooner than expected if inflation continues to surprise on the upside. Attention must also be paid to the economic consequences of the spread of the Omicron variant. This is a data point that the European Central Bank will take into account to adjust its monetary policy if necessary.
There was volatility in the EUR/GBP pair in December, fluctuating within a range of around 270 pips. The pair ended the year close to its 2021 lows. The money market is expecting that the Bank of England will have to raise its key rate again in 2022 to curb inflationary pressures. In December, it had increased its rate to 0.25% versus 0.10% previously. Inflation rebounded to 5.1% in November. The figure for December has not yet been released, but it is expected to be disastrous. Energy prices have reached record highs. The central bank is expecting inflation to continue to rise to a peak of 6% in April. At the same time, economic activity slowed sharply in December due to the Omicron variant, according to preliminary data. The Bank of England is facing a complicated situation, although initially it is likely that it will focus on combating inflation (which is usually its priority) at the expense of supporting economic activity. However, it is expected to tighten monetary policy cautiously in 2022.
The foreign exchange market is not overly concerned about the Omicron variant for the time being. This explains the euro's resurgence against the Japanese yen, which traditionally serves as a safe haven during times of uncertainty. There is nothing new on the monetary policy front. The European Central Bank will not meet until February. The Bank of Japan is maintaining an accommodative monetary policy against a backdrop of low inflation. The consumer price index in the archipelago rose by just 0.1% year on year in October, which is far removed from what is happening in the eurozone or the US. At his December press conference, Governor Haruhiko Kuroda was clear, stating: "I don't think the Bank of Japan will normalise its monetary policy soon."
The EUR/CHF see-sawed for much of December. However, selling pressure increased at the end of December, in a market with no volumes. In his last speech, the Governor of the Swiss National Bank, Thomas Jordan, said that the Swiss currency is at a "high", mentioning the possibility of an intervention on the foreign exchange market "if necessary". For the time being, we have no evidence that the central bank is intervening in FX. However, it is a matter of time before this happens. Since mid-2021, the pair has fallen nearly 4.9%. The Swiss franc is now at a level that is heavily penalising the Swiss export industry. We would not be surprised if the central bank decided to massively buy euros on the market in January to try to curb the rise of the CHF.
Month on month, the EUR/CAD pair ended on a near stable note. However, the Canadian dollar's upward trend is expected to continue in 2022. In 2021, the CAD gained nearly 7% against the single currency. Two main catalysts explain the rise in the CAD: the sharp rise in energy prices in recent months and the difference in monetary policy between the eurozone and Canada. With the ECB maintaining an accommodative monetary policy, Canada has already begun its normalisation cycle. In October, the Bank of Canada ended its exceptional asset purchase programme to counter the pandemic (also known as QE). The market is now anticipating an upcoming rate hike. Investors believe there is a 50% chance that the first rate hike will come during January's meeting, with all of them believing there will be a rate hike in March. The Bank of Canada's monetary tightening could be faster than the US Federal Reserve's, which will also have implications for the USD/CAD pair. Moreover, experts in the commodities sector all agree that energy prices will remain high over the long term, particularly in the case of oil. This is largely the result of a lack of investment in the years leading up to the pandemic. This will also provide substantial support for the CAD in the medium term.
As with many other currency pairs, it is the difference in monetary policy that largely explains the change in the exchange rate. Firstly, the Reserve Bank of Australia is expected to put an end to its asset purchase programme (QE) soon. This will probably be the case as early as February, judging by the minutes of the last meeting on 7 December. Secondly, the European Central Bank remains comparatively accommodating, with a dose of QE maintained beyond 2022. This is referred to as QE infinity. In the short term, this difference will continue to have an impact on the exchange rate. In the longer term, it is well known that this has less effect. The other support factor for the AUD in the coming months could be the continued rise in commodity prices, particularly due to the expected resurgence in Chinese demand.
The EUR/CNH pair see-sawed in December. There are several indications that the Chinese authorities want the trend in the pair to be reversed in 2022 compared to 2021. Over the last year, the euro has tended to depreciate against the CNH. Beijing's economic targets are different for 2022. The priority is to support economic activity, and the easiest way to do so is to stimulate the export sector. One of the main elements for achieving this is a weak currency. We expect the EUR/CNH to appreciate substantially in the coming weeks and months. In addition, the authorities have taken a number of recent measures to support growth, notably by asking banks to lend to real estate players again. All of this points to an influx of liquidity into the Chinese economy in 2022, whereas monetary and fiscal policy was instead seen as restrictive in 2021.
These last weeks, the euro fell slightly against the HUF by 1.51% in a month. The Hungarian central bank is continuing its aggressive monetary tightening policy. It intervened again on 15 December, raising its main policy rate to 2.40% to combat inflation, which has reached a 13-year high. The outlook for 2022 is poor. The central bank expects inflation to be between 4.7% and 5.1%. Fuel and tobacco prices are expected to fall. However, prices of industrial products and services are expected to increase significantly. The rate of growth in food prices could even double! This means that further rate hikes are likely. The Hungarian central bank will certainly have no choice but to be more aggressive in order to preserve Hungarian purchasing power, with a few months to go until the spring general election.
Unsurprisingly, the US dollar continued to rise in December. The USD is capitalising on the start of the monetary normalisation process in the US. Over the past six months, the USD/HUF pair has gained 6.40%, which is an impressive performance. The trend that began in 2021 is likely to continue in 2022. The interest rate hike by the US Federal Reserve means that foreign capital will rather be recycled on the US market, where yields are higher, with the risk taken lower than in emerging economies such as Hungary.