Global Daily – EUR/USD upswing has further to run

by: Georgette Boele , Nick Kounis

Global FX: Higher EUR/USD in 2017 – EUR/USD has risen considerably over recent months;  by more than 5.5% since the start of this year and the pair has now broken above our year-end forecast of 1.10. We expect more dollar weakness and euro strength this year. First, a 25bp Fed rate hike in June is fully discounted and a 25bp rate hike in September is for around 50% priced in. So while we expect two further rate hikes this year, it is unlikely that this will provide strong support for the US dollar. Meanwhile, the market will continue to focus on ECB tapering and this should support the euro going forward. Moreover, the negative headlines about the Trump administration will probably remain. This will depress investor sentiment towards the US dollar and trigger more squaring of speculative net-long USD positions. If investors were to become more negative on the dollar because of the political developments and US data would not surprise substantially to the upside, these positions will likely be cut towards neutral. This could mean another 4% decline in the dollar versus a basket of currencies. Furthermore, the technical picture has turned negative. The US dollar index has broken below the 200-day moving average and EUR/USD above this technical level. This means that speculative investors will look for opportunities to sell the dollar and buy the euro. What will likely dampen the upside in EUR/USD, however, is a refocus on political uncertainty and poor fundamentals in Italy later this year. If we take all the above into account, we now expect more EUR/USD strength in 2017. Therefore, our new year-end 2017 forecast is 1.15 (was 1.10). For 2018 we leave our year-end forecast unchanged at 1.20. For more, please see our note (Georgette Boele).

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Euro Macro: Eurozone core inflation biased by Easter effect – The final estimate from Eurostat confirmed that eurozone core inflation jumped to 1.2% in April from 0.7% in March. This should be music to the ECB’s ears, given all their efforts to get core inflation moving over the last two years. Unfortunately, the rise in core inflation most likely represents distortions from a change in the timing of Easter in this year compared to last. This effect depressed the core rate in March (from 0.9% in February) before pushing up in April. We think that this effect will dissipate from the numbers in May, so that core inflation settles at around 0.9-1%. This would be in line with the flat trend in core inflation that has been in place since mid-2015. The drivers of core inflation suggest it is unlikely to pick up for quite a while. In particular, wage growth remains weak and there is little near term prospect for an significant acceleration given that there is still slack in the labour market. Nevertheless, we still expect the ECB to taper its asset purchases from early next year and shift its communication later this year. The ECB seems to be putting more emphasis on economic growth as a lead indicator of future inflationary pressures rather than waiting for actual (core) inflation to pick-up before changing (communication about) the stance. There are problems in expanding the QE programme through 2018, given the need to keep holdings below the issue(r) limit. As such, the focus on growth is more practical than waiting for underlying inflationary pressures to be visible, as that will take a long time and would necessitate a further extension of asset purchases. (Nick Kounis)