- The euro has continued to slide on monetary policy, growth and politics
- We expect an even weaker euro with EUR/USD at 1.10 by year-end; we see it reaching parity in 2016
- Risk of a Greek euro exit has risen, but it is still most likely that the country will stay in EMU
The euro has continued to head south
The euro has started this year how it ended the last one. In 2014, the EUR/USD declined by 12%, starting at 1.3789 and closing at 1.21. The EUR/USD has fallen further over recent days, and was trading at 1.192 at time of writing. We expect the euro to fall significantly further, and have revised our forecasts even lower.
Monetary policy, growth and now politics
This euro’s weakness versus the US dollar mainly reflects a sharp divergence in growth and monetary policy on either side of the Atlantic. Growth in the eurozone has been sluggish, while inflation has fallen close to zero and is set to turn negative. Indeed, German and Spanish consumer price data suggests inflation turned negative in the eurozone last month and it is likely to stay negative for a few months. The ECB is set to finally embark on large-scale asset purchases. Meanwhile, the US economy has been accelerating sharply, the Fed has ended its QE programmes and is likely to raise interest rates this year. We can now add political uncertainty to the list of euro headwinds given the risks surrounding Greece (see below).
Further euro weakness to come
Monetary policy divergence will likely continue to drive the EUR/USD lower. We expect the Fed to start raising rates in June and to raise interest rates somewhat faster than currently expected by markets. The US economy is set to remain strong. The ECB could well eventually expand its balance sheet by more than a trillion. Given these fundamental drivers and the momentum behind the euro’s fall, we have adjusted our EUR/USD forecasts for this year and Q1 2016 downwards.
EUR/USD: 1.10 by year-end, 1.00 by end-2016
Our new end-of-period forecasts for the coming quarters are as follows: 1.17 (Q1 2015), 1.15 (Q2 2015), 1.12 (Q3 2015), 1.10 (Q4 2015) and 1.08 (Q1 2016). We previously expected EUR/USD to fall more slowly to 1.15 by the end of this year. We continue to expect the EUR/USD to reach parity by the end of next year.
Greece once again captivates markets
We have talked about Greek (and indeed) eurozone political risks on these pages many times. Following the triggering of an early election at the end of last year, investor risk sentiment has deteriorated. The worry is that a Syriza government would unilaterally default on its debt and refuse to stick to any of its obligations, which would lead to an eventual Greek euro exit.
Risks significant, but Greece set to stay in EMU
Our central scenario is that Greece will remain in the eurozone. Syriza has already significantly toned down its stance on many issues, and will likely be more constructive in government than its rhetoric suggests. Germany and other EU countries also have an interest in keeping the eurozone together. Although contagion risks are lower than a few years ago, there may still be a major fall-out from a country leaving EMU.
ND could still pip Syriza to the post
In any case, it is still possible that the ND party wins the elections, given that it has closed the gap on Syriza in the polls. One way or the other the election may end in a stalemate leading to fresh elections. The eventual government will probably be a coalition, which will need to compromise. The uncertainty could well last a while longer.