US Federal Reserve
All the geo-economic and stock market volatility should make central bank chiefs less gung-ho about adding to the costs. Image Credit: Reuters

There are two main aspects to gauge the reason for the weakness in the British pound against the dirham. The first derives from the dirham’s peg to the dollar, and the latter has been gaining across the board as a consequence of the conflict in Ukraine.

In such geo-economic crises, the dollar tends to perform extremely well, and the expectation of aggressive interest rate hikes by the Federal Reserve to counter the rise the inflation. This is fuelling the possibility of profitable carry trades in the near future and also a rebalancing of financial portfolios to add US bonds as returns will rise.

When we look at the underlying situation of the British economy, inflation climbed as much as 7 per cent, a 30-year high, which is leading the Bank of England to reconsider, as we can notice from the dovish tone of latest statements, its plan to aggressively raise interest rates. Chances are that they might not be moved at all during 2022, especially if the Ukraine situation and the subsequent energy and other important supply criss drag on.

A less hawkish Fed?

Another element to consider is the issue arising from the prime minister being under scrutiny for the violation of lockdown rules. Is this situation set to continue, with the pound still losing ground against the dollar? I believe the expectations of aggressive rate hikes by the Fed might start to fade, especially if a solution is found for the Russian-Ukrainian situation.

Truth is even if the stock markets look overheated and inflation rates skyrocket, being too aggressive might lead to serious problems in the US. If we look at the 30-year mortgages, they are 35 per cent higher than those during the mortgage bubble in 2006 that led to the Great Financial Crisis. This is a dangerous situation, as it might ignite a new crisis in the housing and real estate market and a return to massive foreclosures.

Not a repeat of GFC

Even if the systemic impact would not be anything near to that that led to the GFC - as mortgage-backed securities are structured differently - the Fed will need to rethink its way as far as interest rate levels are concerned. If my analysis comes true, the push on the dollar will fade, along with its appeal to investors. Still, this will take time to unfold, and the geopolitical situation will continue to play its role in pushing the greenback. Such a push would be weaker, unless the conflict takes a turn for a worst-case scenario.

From the technical point of view, the GBP-USD cross has been bouncing back from 1.30 area (4.77 area against the dirham), which is a very important technical support that we need to closely monitor, as a breach could lead the GBPUSD to continue to descent to as much as 1.275 (4.68).

For the UAE, while the high prices of oil coupled with a strong dollar are good news, such a situation might lead to more volatility in consumer prices, considering that inflation in UAE is structurally imported. On the other hand, this situation might pull in more attraction from foreign investors.