US Dollar Rises to Near Two Decade High as Fed Tightens Monetary Policy ahead of ECB and BOJ

The US dollar has posted its strongest performance in nearly two decades, as the currencies of other advanced economies including the EU and Japan continue to languish on the back of comparatively loose monetary policy.   

The dollar index rose 0.8% on Thursday to hit 103.83, for its highest reading since December 2002. 

The greenback’s strong performance arrived amidst more vigorous efforts to contain inflation by US Fed, as compared to the European Central Bank (ECB) and the Bank of Japan (BOJ).  

The Fed has recently signalled its strong determination to contain breakneck inflation by raising the cost of borrowing via interest rate hikes.  

The Fed is highly concerned about raging inflation, with the US Consumer Price Index surging 8.5% in March compared to the same period last year.  

That same month the Fed lifted its target interest rate by 25 basis points, while subsequent remarks by Fed chair Jerome Powell and other central bank officials have led many to anticipate two further hikes of 50 basis points in May and June.  

These interest rate hikes mean that dollar assets will produce higher yields than euro or yen-denominated assets, leading to greater demand for greenbacks and an appreciation of their value.  

Inflation is also rife in the Eurozone, accelerating to 7.5% in March from 5.9% in February. Both these figures are streets ahead of the 2% threshold for inflation set by the ECB. 

The ECB has far less latitude to tighten up monetary policy in response however, due to the ongoing war in Ukraine which threatens to undermine Europe’s economic performance.  

Europe remains highly dependent upon energy imports from Russia, leaving it in a precarious position amidst the strong push from Western political leaders to impose sanctions against Moscow.  

The US, EU and UK have jointly sanctioned over 1,000 Russian individuals and businesses in the wake of the Ukrainian conflict. In response Russia suspended its supply of gas to Bulgaria and Poland earlier this week, throwing into relief its ability to apply similar actions against Germany.  

ECB President Christine Lagarde said earlier in April that the economy of the Euro area is likely to suffer most as a result of the military conflict in Ukraine, while the International Monetary Fund (IMF) marked down its 2022 GDP growth projection for the region by no less than 1 percentage point compared to the January forecast.  

As a consequence, the ECB has indicated that it will delay any tightening of monetary policy, which would have the effect of putting the brakes on economic activity already undermined by the Ukraine war.  

On the other end of the Eurasian continent, the Bank of Japan (BOJ) has also indicated that it will refrain from following the lead of the US Fed in tightening up monetary policy, albeit due to a different set of circumstances.  

Japan has yet to suffer from the raging inflation blighting the advanced economies of the West. Its inflation index was up just 1.2% in March – a small change compared to the 7.5% figure for the Eurozone and 8.5% in the US. This means it is under far less pressure to raise interest rates.  

On Thursday BOJ reiterated its commitment to low-interest rates, stating that it would purchase 10-year Japanese government bonds at a yield of 0.25% in order to prevent yields from rising.  

The announcement drove the yen to over 130 to the dollar, for its lowest level since April 2002.  

Given the differing stances of the Fed versus the ECB and BOJ, the US dollar can be expected to hold strong for as long as these contrasting monetary policy settings remain in place.