EURUSD & GBPUSD: Rate hikes are urgently needed

The publication of the August PMIs for the United Kingdom and the Eurozone affirms an ongoing economic slowdown in Europe. The UK Manufacturing PMI fell to 46 from 52.1 in July, indicating the first contraction in factory activity since May 2020 and well below expectations of 51.1.
In Germany, we saw a particularly weak Services PMI at 48.2 down from 49.7 and below expectations of 49.

Worsening economic and trade fundamentals, deep-negative real interest rates, looming recessions, and additional inflationary risks are all contributing to the steady decline of the euro () and the pound ().

The European gas crisis has further accelerated currency movements in recent weeks, with prices and UK gas prices () trading 8 and 6 times higher than prices, respectively.

This creates a substantial competitive disadvantage for European and British companies and exerts downward pressure on the euro-dollar and pound-dollar exchange rates.

Trade flows won't reverse soon because Europe desperately needs to import more LNG from abroad to make up for Russian shortfalls. Instead, significantly speculative financial flows could be curbed through higher interest rates.

Real interest rates in the Eurozone ( - ) and the United Kingdom ( - ) are currently at record lows of -8.4% and 8.85%, respectively.

For a currency hoping to stave off a precipitous devaluation, this is not an encouraging calling card.

With inflation in the UK and the Eurozone predicted to run well double digits in the coming months, the only way to stop the continued depreciation of the euro and the pound is for central banks to announce aggressive interest rate hikes (or even an emergency hike ahead of scheduled meetings in September) regardless of the adverse economic effects.

The ECB and the BoE have a long way to go in their hiking journey. The risk of not doing so now would have far-reaching long-term consequences.

Idea written by Piero Cingari, forex and commodity analyst at Capital.com