Pressure on dollar builds amid possible central bank policy divergence

(Alliance News) - The dollar lost ground against the euro and pound ahead of what could be a testing week for the US currency.

The euro picked up to USD1.1028 on Monday afternoon UK time, from USD1.0992 on Friday. The pound perked up to USD1.2450 from USD1.2419.

The dollar could fall further looking ahead, if US economic data continues to head south, CPT Markets analyst Denys Peleshok commented.

"The US dollar could remain under pressure as traders increasingly view the possibility of a softer monetary policy in the near future as US data continues to show signs of weakness. The effects of the banking crisis could also push monetary policy in the same direction as credit conditions could continue to worsen. Such a trend could affect small and medium-sized businesses in the US and jobs as well as inflation eventually," Peleshok added.

"The focus this week could remain on the US GDP figures that will be published toward the end of the week. Economic activity is expected to have slowed down significantly, which could further cement the current view for a softer monetary policy. The release of these figures could create strong volatility for the dollar."

US economic growth is expected to have slowed to 2.0% on-quarter in the first three months of 2023, according to FXStreet-cited consensus, from a 2.6% rise in the final stretch of 2022.

In data out on Monday, the pace of US economic progress was unchanged on a monthly basis in March, figures from the Federal Reserve Bank of Chicago showed.

The latest Chicago Fed national activity index was unchanged at negative 0.19 points in March. The index had been expected to pick up to negative 0.02 points, according to FXStreet-cited consensus.

A figure above zero would suggest growth is above trend, and a figure below would show growth below trend.

The three-month moving average improved to 0.01 points, from negative 0.09 in February.

The Fed meets next week Tuesday, with a decision and press conference a day later. The central bank is expected to lift rates by 25 basis points.

Ahead of the decision, US banking sector turmoil remains in focus. Going forward, tighter credit conditions from lenders may "finish the job" for the Fed, SPI Asset management analyst Stephen Innes, leading to a policy divergence with other major central banks, including the European Central Bank. This would heap pressure on the dollar.

"The Fed is counting on tighter credit conditions to help 'finish the job'.The ECB seems unlikely to have much assistance bringing potentially even more persistent inflation pressures back to target. A strong inflation report for April could tip the scales for another 50 [basis point] increase at the next meeting. This raises the probability of more divergence than currently priced, which would lift the current cap on EUR/USD targets this year. The big worry for the euro bulls is that the ECB could face credit concerns at some point, with sovereign spreads still a potential risk as policymakers work to slow the nominal growth that has mitigated spread widening," Innes added.

As far as the Bank of England goes, a robust UK inflation reading means policymakers are odds-on to lift by another 25 basis points.

"Expectations for another increase in bank rate next month have risen, with a 25 [basis point] increase to 4.5% on 11 May fully discounted by interest rate markets, while also pricing in more tightening through the summer months. Over the weekend, BoE Deputy Governor Ramsden said that officials must not get 'knocked off course' in their bid to rein in inflation," Lloyds.

By Eric Cunha, Alliance News news editor

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