War, inflation and interest rates – How were currency markets shaped by the events of 2022?

2022 proved to be another volatile year for the currency market. While we emerged from the other side of the Covid pandemic, the outbreak of the largest war in Europe since WW2 rocked the global economy.

The war in Ukraine exacerbated global inflationary pressures. Sparking a sharp rise in the cost of living and leading to a series of massive interest rate hikes from the major central banks.

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What happened in 2022?

The lifting of Covid restrictions by most major economies looked to be a positive sign for global growth in 2022. However, Vladimir Putin’s invasion of Ukraine at the end of February almost immediately derailed things.

The outbreak of the war in Ukraine weighed heavily on the euro in the first quarter, amid fears the Eurozone economy would be heavily impacted by the conflict and the sanctions imposed on Russia by Western powers. At the same time, the US dollar began what would be an extend bullish run through the majority of 2022 as jittery investors flocked to the safe-haven currency.

Rising inflation was already a point of concern for most major central banks before Russia’s invasion. But the war turbocharged these inflationary pressures as it triggered a dramatic increase in global energy prices.

As a result, 2022 was marked by a startling rise in consumer prices. While the US and Eurozone both experienced a sharp acceleration of inflation, the UK proved particularly vulnerable. Concerns over the UK’s cost of living crisis acted as a major headwind for the pound throughout much of the year.

In an effort to tame inflation, the Bank of England (BoE), European Central Bank (ECB) and Federal Reserve embarked on a new tightening cycle.

The Fed proved to be far more aggressive with its interest rate hikes than its peers, however. With a series of massive 75bps hikes helping to propel the US dollar to new multi-decade highs and even pushing the EUR/USD exchange rate below parity for a few months.

In addition to this, the prospect of much higher interest rates from the Fed, BoE and ECB fuelled global recession fears. Reinforcing the appeal of the safe-haven US dollar.

Meanwhile, political uncertainty in the UK proved a major source of volatility for the pound over the summer. After his administration being dogged by scandal for months, Boris Johnson resigned in July, to be replaced by Liz Truss in September following a lengthy leadership contest.

However, Truss’s ill-fated premiership proved even more volatile than her predecessor’s. Her plan for massive unfunded tax cuts spooked markets and saw the GBP/USD exchange rate collapse to a record low in late September.

Come back in the new year at our currency forecast for 2023.