There’s a non-pandemic catalyst set to drive the dollar, pound and euro for the rest of 2021

Currency traders are shifting their attention away from the coronavirus pandemic when it comes to the dollar, euro, and pound and are focusing instead on central banks’ potential policy choices to combat rising inflation this year.

The widespread availability of vaccines in the U.S., the U.K., and most European Union nations is helping to mitigate the impact of the pandemic on those economies. Meanwhile, the unleashing of pent-up consumer demand, coupled with supply shortages, has sent inflation higher in the U.S., a trend being seen across much of the developed world, according to Ebury, a London-based provider of currency solutions.

The more-than-$6-trillion-a-day currency market operates around the clock, with a breadth and liquidity that few other markets can match and the potential to impact other asset classes, like stocks, bonds and commodities. It’s especially adept at quickly sizing up multiple developments across geographical regions, such as the “supercycle” demand for commodities earlier this year that led to greater interest in commodity-linked currencies.

“With concerns surrounding the virus abating, aside from localized flare ups in infection caused by the delta variant, we think that the main driver of the major currencies in the second half of the year will be how central banks respond to rising inflationary pressures,” Ebury’s Chief Risk Officer Enrique Diaz-Alvarez, along with analysts Matthew Ryan and Roman Ziruk, wrote in a note Monday.

The British pound GBPUSD should be able to post “reasonable gains” over the U.S. dollar through next year, considering that the Bank of England is likely to normalize its policy sooner than either the Federal Reserve or European Central Bank, they said. Almost all of the virus restrictions in England have been removed, allowing the U.K. economy to outperform most of its major peers this year, and the first BOE interest rate hike of 15 basis points could come around next May or August, according to Ebury.

Meanwhile, the firm remains bearish on the dollar, which should depreciate “versus most of its peers over our forecast horizon” — even though it doesn’t expect the recent spike in U.S. inflation to be particularly lasting. The ICE U.S. Dollar Index DXY, a measure of the currency against a basket of six major rivals, was up 0.5% on Tuesday.

The bearish view is predicated on two things, according to Ryan, a senior market analyst. Besides being “generally optimistic about the global economic recovery,” he said in a follow-up e-mail to MarketWatch, “we also think that the FOMC will take a rather cautious approach to raising interest rates given the rather strong political pressure against tightening. We do not think that the Fed will begin hiking rates until late-2022 at the very earliest, which may put it behind the curve in relation to more than half of its G10 peers.”

Ebury sees the GBP/USD pair climbing to 1.45 by the end of 2022, versus 1.37 as of Tuesday.

As for the euro EURUSD, the ECB’s more dovish tone has caused the market “to push back” expectations for policy normalization and sent the euro to its lowest level against the dollar in four months. The recent move lower in the EUR/USD “has perhaps been

excessive,” and a likely convergence in the economic performances of the U.S. and euro area in the current quarter “should support the euro in the near-term,” according to Ebury. Still, inflation pressures in the euro area are lagging and the ECB seems to be in no rush to normalize its policy, causing Ebury to revise its near-term EUR/USD forecasts lower.

To be sure, the coronavirus is still very much on the minds of traders with regard to currencies like the New Zealand dollar. On Tuesday, the kiwi NZDUSD slid after the island country placed its largest city, Auckland, into lockdown for seven days following the first case of Covid-19 in the community since February.

And the pandemic is still weighing on equities. The Dow Jones Industrial Average DJIA and S&P 500 Indexes SPX each dropped Tuesday on weaker-than-expected retail sales that some analysts linked to the spreading delta variant, prompting a decline that threatened to end a five-day run of record finishes.

“Countries that have the luxury of vaccines and successful rollouts are the exceptions,” Marc Chandler, managing director of Bannockburn Global Forex, said via phone. “In some places, like New Zealand, Australia and southeast Asia, the virus is still affecting policy.” Even so, “the market expects policy makers in the U.S., U.K. and Europe to look past the rise of Covid-19 cases and to focus on policy.”