The Impact of a Strong Dollar versus the Pound and Euro
Published / Last Updated on 02/11/2022
In recent months we have seen a strong US Dollar (USD) $ versus the UK Pound (GBP) £ and the Euro (EUR) €. What is the impact of having a strong currency and the knock-on effect to other currencies, their economies, inflation, and their import/export markets?
The $ is currently much stronger than the £ or € because the US is not reliant at all on Russian oil and gas. The UK is not as reliant on Russia with just 4% of oil and 9% of gas (figures 2021), totalling £4.5bn per year. Europe is much more reliant and was importing 31% of its energy needs from Russia in 2021. With effect June 2022, UK imports of fossil fuel from Russia finally hit zero and, whilst it is falling in the EU, they are still spending €10bn every month. This makes the EU much more vulnerable to high energy costs and Russian restrictions.
Interest Rates
Central banks use interest rates to try to control and bring down inflation. With the US not relying on Russia, the economy strong and inflation still high, the Federal Reserve has been able to take more aggressive action with interest rates. At 2pm EST today, around 6pm UK GMT tonight, the Federal Reserve looks set to increase rates yet again, we predict by another 0.75% taking rates up to a range of 3.75% to 4% pa, its highest in 14 years. This will help curb inflation. We also expect the Bank of England to take similar action tomorrow (Thursday 3rd November) increasing rates by 0.75% from 2.25% to 3% pa. This will strengthen further the $ and if the UK follows suit, the £ should maintain it still weaker position against the $ but should strengthen against the €.
Impact of Higher Interest Rates and a Stronger Currency
Energy such as oil, gas and commodities are usually priced in $. This means with a weaker £ or €, energy, goods and services imports are more expensive. You could say that by the Fed increasing interest rates and strengthening the $, it is exporting more inflation to the rest of the world by making many goods and service priced in $ more expensive. This drives UK and EU inflation up more than it would be normally forcing the Bank of England and the European Central Bank to consider increasing rates even further. This then makes our mortgages more expensive with more repossessions likely, falling house prices as well as business borrowing costs increasing, with more redundancies, economic slowdown and forcing us into recession.
Head in the Noose?
Inflation is fundamentally as combination of government fiscal policy and central bank interest rate/inflation policy. If the government does not increase taxes (remember Kwarteng’s disastrous Mini Budget) and just borrows more to pay for handouts, confidence is lost and the costs of government borrowing rise. Add to this, central banks need to increase rates to curb inflation. The government is walking a tightrope with its ‘head in a noose’.
Strong Currencies Hurt the Economy Too
With US interest rates higher and a strong $, this means that foreign imports into the US are cheaper i.e., British export goods to the US are cheaper, as are Chinese, Japanese and European exports to the US. This may hurt US businesses but will reduce inflation for the US consumer. A strong $ also means that US exports are more expensive and will hurt major US exporting businesses that may push US stock markets down.
All the above may also apply to the UK if the Bank of England increases interest rates by our forecast 0.75% tomorrow. Mortgage costs will increase, and recession is all but here now.
Our Equities (stock markets) v Bonds (lending to governments/government debt) Rules
- Buy equities in countries that have a weak currency, in particular companies that export goods and services, selling overseas cheaper as currency weak.
- Drip feed out of equities and buy bonds in countries that have strong currencies as their exports are more expensive and imports are cheaper. This means that inflation will fall quicker meaning the interest rates will be reduced earlier and the capital value of bonds will rise.
We wait with expectation on tonight’s Federal Reserve rate increase and tomorrow’s likely rate increase by the Bank of England. We expect 0.75% increases from each as you know. You now also know that impact og higher interest rates and stronger currencies.
