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20 May 2015
3 reasons the euro may weaken going forward - Capital Economics
FXStreet (Bali) - Kevin Ferriter, Economist at Capital Economics, thinks that unconventional monetary policy is one of three reasons that the euro may weaken going forward, expecting the EUR/USD rate to hit parity by year end.
Key Quotes
"The euro has come under renewed pressure this week after a month during which it appreciated by around 8 cents against the dollar from $1.06 to $1.14. It fell particularly sharply on Tuesday following indications from the ECB that it intends to increase its asset purchases in May and June ahead of a period in the summer in which it expects liquidity to be lower than normal in government bond markets. Although they are just shifting the timing of asset purchases that would have taken place anyway, we think that unconventional monetary policy is one of three reasons that the euro may weaken."
"First, though there has been speculation that the ECB may curtail its asset purchase programme now that inflation and growth expectations have begun to pick up in the euro-zone, we are sceptical that this will happen. After all, medium term inflation expectations are still below the ECB’s target. What’s more, even if they did curtail the programme, this may not prevent the euro from depreciating, as much of the impact of the asset purchases on growth may be unwound."
"Second, although we are in line with the consensus in expecting that the ECB will keep its key policy rate very low for the foreseeable future, we expect the Federal Reserve to increase interest rates through 2016 more aggressively than either policymakers or investors currently anticipate. Accordingly, the euro could also come under pressure from conventional monetary policy in the US."
"Third, a resolution could be reached between Greece and its official creditors. However, we are not confident that a deal will be struck. The current negotiations are only over Greece receiving the final payment of its existing bailout, so even if these negotiations are successful, this just kicks the can down the road. And it seems likely that negotiations over a third bailout would be even more fractious than the current set have been. So a “Grexit” remains a distinct possibility. (For more, see our European Economics service.) Overall, we continue to forecast the euro to end the year at parity against the dollar (down from $1.12 now.)"
Key Quotes
"The euro has come under renewed pressure this week after a month during which it appreciated by around 8 cents against the dollar from $1.06 to $1.14. It fell particularly sharply on Tuesday following indications from the ECB that it intends to increase its asset purchases in May and June ahead of a period in the summer in which it expects liquidity to be lower than normal in government bond markets. Although they are just shifting the timing of asset purchases that would have taken place anyway, we think that unconventional monetary policy is one of three reasons that the euro may weaken."
"First, though there has been speculation that the ECB may curtail its asset purchase programme now that inflation and growth expectations have begun to pick up in the euro-zone, we are sceptical that this will happen. After all, medium term inflation expectations are still below the ECB’s target. What’s more, even if they did curtail the programme, this may not prevent the euro from depreciating, as much of the impact of the asset purchases on growth may be unwound."
"Second, although we are in line with the consensus in expecting that the ECB will keep its key policy rate very low for the foreseeable future, we expect the Federal Reserve to increase interest rates through 2016 more aggressively than either policymakers or investors currently anticipate. Accordingly, the euro could also come under pressure from conventional monetary policy in the US."
"Third, a resolution could be reached between Greece and its official creditors. However, we are not confident that a deal will be struck. The current negotiations are only over Greece receiving the final payment of its existing bailout, so even if these negotiations are successful, this just kicks the can down the road. And it seems likely that negotiations over a third bailout would be even more fractious than the current set have been. So a “Grexit” remains a distinct possibility. (For more, see our European Economics service.) Overall, we continue to forecast the euro to end the year at parity against the dollar (down from $1.12 now.)"