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Currencies ‘doing the dirty work’ for central banks, says HSBC

Who needs central banks when you can have freely floating currencies instead? That’s the question posed by HSBC.

The currencies market is “the new central bank”, it writes in a note, pointing out that “FX has delivered the initial tightening as policymakers pull back from ultra-loose monetary conditions”.

The dollar got the ball rolling, rallying (at least at first) once the market sniffed the chance of a series of rate rises. Now, it’s the euro’s turn.

Rather than using the blunt instrument of policy rates to head through the exit from ultra-accommodative monetary policy, central banks have recognised the value of letting the currency test the ground first. The tactic has been to move the market conversation towards that of exit. This is sufficient to get the currency strengthening, instigating a tightening but through a channel which can be easily reversed without the kind of jolt that a policy interest rate reversal would entail. This is not about direct FX intervention but it is about getting the currency to do the dirty work, at least initially. If all goes well, then the central bank can raise rates.

We believe the Australian dollar, New Zealand dollar, Swedish krona and Norwegian krone will be the next to move as it becomes clear that these central banks are moving to a tighter policy. We therefore revise our forecasts, looking for appreciation in all of these currencies.

By the middle of next year, the bank expects the Aussie dollar to be at US$0.90, from a previous forecast of US$0.75. (It’s now at US$0.81.) For the Kiwi dollar, it is now eyeing US$0.78, from US$0.70 (now US$0.72.) The US dollar is likely to be at C$1.20 against the Canadian dollar, from a previous estimate of C$1.25 (now C$1.21).

For the Nordic currencies, the bank expects the euro to trade at SKr9.00 against the Swedish krona, from an earlier assessment of SKr9.80, while it also expects one euro to buy NKr8.80, from NKr9.00 previously. (Now SKr9.53 and NKr9.30.)