Slumbering euro poised to awaken

LONDON: The euro may have had a slow start to the year, but that hasn’t deterred its fans. The common currency has been rangebound since the January meeting of the European Central Bank, when the fervour about tighter policy that had driven it higher began to cool.

Now that it appears to have weathered the worst-possible outcome in the March 4 Italian election, bullish views on the euro are re-emerging, with Goldman Sachs, Morgan Stanley and ING all betting the euro will end the year stronger.

The euro, currently trading around US$1.23, is one of Goldman’s preferred Group-of-10 currencies, especially versus the yen. Morgan Stanley sees the euro ending the year at $1.30, while ING has a “high conviction” call of $1.35 in 2019.

The upbeat views come as the ECB prepares to end quantitative easing by year-end and speculation builds that it may increase interest rates in 2019. That helped the euro touch a three-year high of $1.2555 on Feb 16, amid elevated German bund yields. As long as the ECB’s direction keeps the uptrend in yields intact, the euro should also continue to head higher, according to Societe Generale.

“The euro is bound to rally because of the two-step ECB policy normalisation,” said Petr Krpata, a currency and rates strategist at ING. “One step is already under way with the preparation for QE tapering. We think that the next step the market is not fully prepared for is the ECB lifting its deposit rate.”

With the premium paid to investors to hold US bonds over German debt at the highest since at least 1990, bund yields are vulnerable to significant moves higher triggered by policy shifts in Europe, which ING said could prove a powerful driver for the euro.

While this may be a story for 2019, with the Dutch bank forecasting the first deposit-rate increase in the middle of that year, the market will likely “front run” that development, pushing the shared currency higher later in 2018, Krpata said.

Despite the euro’s 19% ascent against the dollar since January last year, the shared currency remains relatively cheap, so $1.30 is “not particularly crazy”, said Jordan Rochester, a Nomura strategist who sees the euro going to $1.40 by the end of 2019.

Not all analysts share such an upbeat outlook. The ECB faces a daunting task to withdraw stimulus at a slow enough pace to not jolt markets, with President Mario Draghi assuring investors that monetary policy “will remain patient, persistent and prudent”.

Still, the euro also has factors other than monetary policy in its favour. Euro-dollar is the G10 currency pair most sensitive to global equity performance, meaning it would be the “primary beneficiary” in an environment of improving risk sentiment, according to BNP Paribas strategists.