6 drivers of EUR/USD exchange rate in 2022 according to the ECB

The EUR/USD is the main currency pair of the FX dashboard, both by the volume traded and its popularity among retail traders. The exchange rate jumped almost one thousand pips in the last couple of months but is still well below the 2022 opening levels.

In the first half of November, Phip Lane, Member of the Executive Board of the ECB, talked about the global economy at the 23rd Jacques Polak Annual Research Conference. Among other things, such as the HICP inflation and components in the euro area, Lane discussed the drivers of the EUR/USD exchange rate since 2021.

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He mentioned six factors responsible for the volatility of the EUR/USD exchange rate:

  • Euro area macro environment
  • US macro environment
  • Global risks
  • Euro area monetary policy
  • US monetary policy
  • Commodities terms of trade

Out of the six, two stand out of the crowd: the Fed’s aggressive interest rate hikes and the negative terms of trade shock triggered by the rise in energy prices.

Fed’s aggressive interest rate hikes

The chart above presents how much each of the six factors contributed to the fluctuation of the EUR/USD exchange rate. By far, the US monetary policy is the main driver of it.

The Fed’s tightening cycle is one of the most aggressive in history. It delivered three consecutive 75bp rate hikes in 2022 alone in a major effort to bring inflation down.

2022 was a midterm year, so rising inflation was also a political issue. By tightening the way it did, the Fed outpaced other central banks, such as the European Central Bank.

As such, traders bought the US dollar across the board, especially against the euro, as the interest rate differential between the two remains one of the largest in the advanced economies.

Commodities terms of trade

Commodities’ terms of trade were in second place as a factor influencing the EUR/USD exchange rate. More precisely, the rise in energy prices triggered a negative terms of trade shock, which weighed on the common currency.

As if the COVID-19 pandemic was not enough, the euro area suffered an additional energy shock from the war in Ukraine. After Russia invaded Ukraine, the energy prices in Europe jumped through the roof, putting pressure on the common currency and the European economies.

So why is the EUR/USD off its lows in the last two months? One reason is the Fed, as the market anticipates that the US central bank will pivot and slow down the pace of its interest rate hikes. Another reason is that energy prices have come down from their highs.

Should the recent trend in the Fed’s policy and global energy prices continue, the EUR/USD exchange rate could rise some more.

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Source: https://invezz.com/news/2022/11/28/6-drivers-of-eur-usd-exchange-rate-in-2022-according-to-the-ecb/