FX Forecast Update: Fundamental EUR Support Still Intact

Key points

• Driven primarily by huge monetary divergence between the ECB and Fed, we still expect EUR/USD to continue higher, reaching 1.50 in six months’ time.
• The tragic earthquake in Japan has postponed our projected JPY weakening. We see downward pressure on USD/JPY over the next three months.
• Upside risks to EUR/GBP have reemerged, coming both from economic and financial fronts. We project a return to 0.89 in three months’ time.
• The latest setback has made the Scandies attractive again.
• The CHF remains supported by the MENA turmoil and other drivers for risk aversion.

While the tragic events following the recent earthquake in Japan combined with continued unrest in the Middle East and North Africa region have the potential to de-rail global risk sentiment, we maintain our view that medium- to long-term euro support remains intact. Hence, we still look for EUR/USD to reach 1.50 on a 6M horizon. USD/JPY.

The outlook of an ECB rate hike in April combined with a soft Fed supports our longheld view of a stronger euro vs US dollar, (see Yield Forecast Update). EU leaders agreeing on important issues over the weekend, see A turning point for the debt crisis, suggests to us that the euro is pulling through and should trade with a smaller risk premium going forward. We stick to our 7 March interim update of the EUR/USD forecast and project 1.46 (3M), 1.50 (6M) and 1.42 (12M).

The main risks to our forecast for a stronger euro is that the Fed will turn hawkish earlier than expected; that the European debt crisis will escalate again; or that geopolitical tensions will prompt a further spike in the oil price to the point where it stops being dollar negative (i.e. when oil prices rise so much that it questions the global recovery and hence leads to a sell-off in risky assets). There is of cause also a risk that EUR/USD will rise markedly above our 1.50 target. This could be triggered by a 2008-style feedback loop where a higher oil price pushes EUR/USD higher, which in turns pushes the oil price up and stimulates speculative long positions, etc.

The deadly earthquake in Japan could potentially lead to massive repatriation flows and a stronger yen for longer. We have postponed our projected rise in USD/JPY to H2 and look for a broadly flat yen around 82 on a 3M horizon. By year-end, the yen should face headwinds due to lack of support from relative rates.

The pound is, in our view, losing on two important fronts: economically and financially. The rate spread between the Eurozone and the UK will widen further when it emerges that the current weakness of the UK economy isn’t temporary, when the Eurozone countries move closer together and the ECB delivers while the Bank of England sits tight for longer. We have raised out EUR/GBP forecast to 0.89 (3M), 0.89 (6M) and 0.86 (12M).

We expect relative rates to support both the SEK and the NOK. The Riksbank has already signalled that it plans to continue hiking rates vigorously in 2011 and Norges Bank is expected to resume its hiking campaign in May. We forecast that EUR/SEK and EUR/NOK will fall to 8.50 (6M) and 7.70 (6M), respectively.

Relative rates together with general euro strength are also expected to push EUR/CHF higher. We now expect EUR/CHF to hit 1.35 (6M). But look out for the first SNB hike that might come in September.

Full Report in PDF