We have revised our EUR/USD forecasts lower to reflect the announcement of the ECB’s aggressive QE programme and that SNB will buy fewer euros following the lifting of the floor in EUR/CHF. Our new forecasts for 2015 and 2016 are 1.05 and 0.95 respectively, from previously 1.10 and 1.00. The global easing cycle continued with the Reserve Bank of Australia, PBoC and the central bank of Denmark easing monetary policy. This affected their currencies. However, commodity currencies firmed due to profit taking and a recovery in commodity prices.
New EUR/USD forecasts…
Earlier this week we have revised our EUR/USD forecasts lower. For starters, the announcement of the more aggressive ECB’s quantitative easing program has pushed the euro lower. Moreover, the Swiss National Bank will buy fewer euros since it has discontinued the floor in EUR/CHF on 15 January. However, there is some speculation that that it has recently intervened to push EUR/CHF somewhat higher. It is unlikely that these interventions will approach the amount of euros bought under the EUR/CHF floor. As a result of these forces, we have lowered our EUR/USD forecasts for the end of 2015 and end of 2016 to 1.05 and 0.95 respectively, from previously 1.10 and 1.00. We remain confident that the Fed will start its hiking cycle around mid-2015 and hike by more than financial markets now expect.
US employment report surprised on the upside. As a result, US short-term rates, Treasury yields and the US dollar moved sharply higher.
Central bank easing continues…
The Reserve Bank of Australia cut interest rates by 25bp to 2.25%. The decision to cut rates was in line with our expectation but was earlier than market consensus. As a result, the Australian dollar (AUD) was aggressively sold off from 0.78 to below 0.77. However, this was followed by profit taking and the Australian dollar recovered most of its losses as technical indicators imply that the Australian dollar is heavily oversold. We expect another 25bp rate cut no later than May. A lower AUD/USD towards 0.72 is expected as the economic and monetary policy divergence between Australia and the US widens later this year.
…PBoC cut reserve requirement ratio…
The People’s Bank of China joined the global easing cycle by cutting reserve requirement ratio to 19.5% to support the economy. It also raised the yuan’s reference rate to a level that forced appreciation. So in a way, it neutralised the impact of monetary policy easing on the yuan, because the PBoC does not want much yuan weakness.
…and the Danish central bank cut rates further
On 5 February the central bank of Denmark further reduced the interest rate on certificates of deposit by 0.25bp to -0.75% (see graph below). It announced that the “interest rate reduction follows Danmarks Nationalbank’s purchases of foreign exchange in the market. The fixed exchange rate policy is an indispensable element of economic policy in Denmark – and has been so since 1982. Danmarks Nationalbank has the necessary instruments to defend the fixed exchange rate policy for as long as it takes. There is no upper limit to the size of the foreign exchange reserve. The sole purpose of the monetary policy instruments is maintaining a stable krone exchange rate against the euro. The revenue of Danmarks Nationalbank is positively affected by the increase of the foreign exchange reserves.”
The main objective of Danmarks Nationalbank is to ensure stable prices, i.e. low inflation (below but close to 2%, similar to the target of the ECB). This is achieved through the monetary and exchange rate policy. Its policy is aimed at keeping the krone stable against the euro. Usually it changes its interest rates in sync with policy rates of the ECB.
It is likely that the central bank will continue to intervene in currency markets and that it will cut interest rates further because of the absence of QE in Denmark (apart from FX intervention) and inflation being far below the target.
We judge that the abandoning of the EUR/DKK peg is unlikely. For starters, since the 1980s Denmark has had its exchange rate anchored to the Deutschmark/euro, as it judged that the resulting stability would have positive effects on inflation and growth. The eurozone is its largest trading partner. For example 38% of its exports are destined to the eurozone. As Denmark is part of ERM2 the ECB is also committed to protecting the peg (see our Denmark Watch: “DKK peg to remain in place”.
Riksbank’s turn next week
On 12 February, the Riksbank will decide on monetary policy. After the announcement of the ECB’s aggressive easing programme, the actions of the Swiss National Bank and central bank of Denmark, it is now the turn of the Riksbank. It is likely that also the Riksbank will surprise financial markets by more aggressive monetary policy easing. The market has partly anticipated a cut in the reference rate to negative (the depo rate is already -0.75%). However, quantitative easing remains on the cards as well, taking into account that inflation is considered as being far too low. It addition, a weaker Swedish krona would help to create some inflationary pressures.
Commodity currencies recover
In the past week, commodity currencies recovered on the back of profit taking in the US dollar and a recovery in underlying commodity prices. The bounce in oil prices supported the Norwegian krone, Canadian dollar and the Russian ruble. This has resulted in some scaling back of rate cut expectations.
The New Zealand dollar (NZD) rebounded by almost 2% after the Reserve Bank of New Zealand (RBNZ) poured cold water over market speculation that a rate cut is imminent. The RBNZ stated that the domestic economy is performing well and reinforced our view that a weak headline inflation is not reflective of underlying cost pressures in the non-tradable sectors of the economy. Nevertheless looser monetary conditions will be warranted if domestic demand deteriorates or inflation is weaker than expected. We maintain our view that the RBNZ is likely to keep monetary policy unchanged until late 2016. Nevertheless we remain bearish in the NZD as we expect the RBNZ to intervene in the currency market to weaken the NZD given that it considers the currency to be overvalued.