Deutsche Bank expects the ECB and Fed monetary policies to diverge. Also, the Bank of England is seen raising rates twice, while the Bank of Japan to keep them on hold. 

Monetary policy is the main driver of the FX market’s volatility. Often, it is the only driver, as traders interpret economic data only to form an educated guess about what the central bank will do next.

The major central banks (i.e., Federal Reserve, European Central Bank, Bank of England, Bank of Japan) face a tough year ahead. On the one hand, economies recovered from their pandemic lows, and so most of the stimulus needs to be removed. On the other hand, removing the financial accommodation too soon or too fast bears the risk of slowing the recovery.

Deutsche Bank’s research focused on what the major central bank will do in 2022. The Fed and the ECB are seen as having divergent policies, while the Bank of England is forecast to continue the tightening cycle. Finally, the Bank of Japan is set to keep rates on hold.

Fed – first rate hike expected in March

According to the forward guidance provided recently, the Fed is on course to deliver its first rate hike in March. The big question now is the size of the move – 25 or 50 basis points?

To many investors, the Fed needs to act decisively to restore its credibility. After all, inflation is running hot at a nearly four-decade high and well above the target, while the interest rates remain at their lower boundary.

ECB to stay on hold

Deutsche Bank sees the ECB on hold in 2022, thus diverging from the Fed’s monetary policy. Only on these grounds, the EUR/USD should have a hard time advancing, but markets function a bit differently.

For instance, despite the ECB insisting that it plans no hikes in 2022, the eurozone money markets now price in a 20 basis points rate hike by December.

BOE to raise rates twice in 2022

The Bank of England surprised markets by delivering a first-rate hike last December. Moving forward in 2022, Deutsche Bank expects another two rate hikes as the UK economic recovery continues and inflation is well above the central bank’s target – 5.1% vs. 2% target.

BOJ to keep rates on hold

The Bank of Japan is seen as keeping rates on hold throughout 2022. However, it may surprise markets by changing its inflation wording and loosening its grip on the yield curve.