The euro, which appeared set for parity with the US dollar less than six months ago, is poised to extend its year-to-date rally, bolstered by upbeat economic data and cautious optimism from ECB chief Mario Draghi.
The single currency held steady onTuesday, albeit in thin trade, after the president of the European Central Bank told EU lawmakers in Brussels that the “economic upswing is becoming increasingly solid and continues to broaden across sectors and countries”, and “downside risks to the growth outlook are further diminishing”.
Still, Mr Draghi isn’t signalling any rethink just yet: “We remain firmly convinced that an extraordinary amount of monetary policy support, including through our forward guidance, is still necessary.”
His comments come amid a heightening debate within the ECB, including from Bundesbank chief Jens Weidmann, about planning for a return to more normal policy as inflation turns more positive. The eurozone’s May CPI estimate is scheduled to be released on Wednesday, and that is seen as the next key trading data point for the single currency.
The euro was fetching $US1.1129 on Tuesday, about 1 cent off recent nine-month highs. The currency has traded between $US1.11 and $US1.12 for most of the last two weeks, lifting its year-to-date advance to more than 6 per cent with an increasing number of forecasters seeing $US1.15 within reach and perhaps even $US1.20 over the next two years.
The euro also has recovered against the Australian dollar; the Aussie is trading near 66.64 euro cents – a 2.7 per cent year-to-date decline. Forecasters see losses widening, perhaps to a sub 60 euro cents level, reflecting a divergence in overall monetary policy stances and interest rates in particular.
Europe’s currency is a far cry from the $US1.0341 it plumbed in late December, when talk of imminent parity with the US dollar was rampant.
The euro sank during the second half of 2016 in the wake of the UK’s decision to exit the European Union last June, the European Central Bank’s decision to extend its asset-buying program and reinforce its ultra-loose monetary stance in early December, and the US Federal Reserve’s decision to lift interest rates and signal the potential for three more hikes in 2017 in mid December.
More upside for the euro
“Looking ahead we think the euro still has a fair bit of upside, but our sense is that the (euro/$US) pair is likely to do a bit of work around the 1.11/12 (level) before it heads higher again,” said NAB currency strategist Rodrigo Catril. “Our forecast is for the euro to end the year at 1.15, but given the pair’s swift appreciation of late, the risk is that we get there sooner rather than later.”
“As for our AUD/EUR view, we think the pair is likely to be face strong downward pressures, both from the USD and EUR arguments mentioned above,” Mr Catril said. “Putting our AUD/USD and EUR/USD views together leads to our forecast for AUD/EUR dropping to 62 euro cents by year end and then sub 60 next year.”
Among the reasons for the return of positive sentiment on the euro is what Mr Draghi noted, that the eurozone economy is expanding at its fastest pace in six years. The IHS Markit Eurozone PMI held steady at 56.8 in May, according to data released last week, unchanged on April’s six-year high, according to the preliminary flash estimate.
Business activity is expanding in the second quarter at a pace “consistent with 0.6-0.7 per cent GDP growth”, said Chris Williamson, chief business economist at IHS Markit, faster than the consensus of 0.4 per cent.
The improving economic picture — Capital Economics’s Jennifer McKeown recently revised higher her forecast for eurozone growth to about 2 per cent this year — has helped bolster the euro.
Citigroup also has turned bullish, updating its forecast for eurozone growth to 2 per cent for 2017 from an expected 1.6 per cent last year. It sees growth hovering at 1.9 per cent in both 2018 and 2019. Citi’s forecasts are higher than the EU Commission, the International Monetary Fund and the ECB’s mid point: each forecast 1.7 per cent this year, before edging down to 1.6 per cent in 2018.
“There is a common trend in the incoming dataflow across the euro area indicating that the four-year long economic recovery is strengthening and broadening out across both countries and economic sectors,” according to Citi’s monthly European economic forecast monitor dated May 25.
ECB in focus
Still, no one is expecting any policy tweak at the ECB’s June 8 meeting.
Citi doesn’t foresee a decision on asset purchases until September at the earliest and it’s not expecting a rate rise until mid 2019: “a year after the likely end of net asset purchases”.
Capital Economics sees the ECB tapering asset purchases to zero in the first half of 2018, which “we think is roughly priced in by financial markets”, said Ms McKeown, with the ECB waiting until “the start of 2019” for a rate hike.
The euro’s rally so far this year has been unexpected, given the ECB’s loose policy versus Fed tightening. That should have put “downward pressure on the euro”, Ms McKeown said, but it hasn’t happened.
Ms McKeown points to the results of national elections earlier this year in both the Netherlands and France which “helped ease fears about euroscepticism”. Meantime, there also are increasing concerns about the ability of US President Donald Trump to put his agenda into place, dampening demand for the US currency.
The reality is that the pendulum has swung in the euro’s favour and it has momentum on its side.
“The rally is only starting for the euro-US dollar pair,” said Naeem Aslam, chief market analyst at ThinkMarkets UK. “The fact is that the ECB is increasingly becoming bullish with its stance and there is more to come on that.”