With ECB policy now directly targeting EMU external competitiveness, EUR should weaken throughout Q4 and we have adjusted our forecast profile lower accordingly. Combined with reserve-rebalancing pressures, EUR/USD should decline to 1.28 during Q4.
From a pure currency perspective, the latest ECB policy turn is likely to drive an even greater ‘yield-wedge’ between EUR, USD and other core currencies. Having already fallen nearly 5% from its July peak, this wedge should see the EUR trade-weighted index (NEER) fall by another 5% during Q4.
Indeed, with a majority of investors surprised by this greater ECB determination to lift Eurozone competitiveness, such selling pressure should prove relatively consistent. European manufacturers will undoubtedly welcome this boost to the ‘terms of trade’ (ie, relative export import price ratios) given increasing Asian competition all along the export-value chain.
In terms of the external sector, ECB policy actions will also amplify the negative impact of central bank reserve-recycling upon EUR. As the Fed has tapered QE, this has slowed passive USD reserve accumulation and in turn active USD reserve-rebalancing into EUR and other currencies. This latest ECB policy shift, however, could encourage an acceleration of this rebalancing trend. In particular, those reserve managers’ who were previously unwavering in their EUR support (predominantly those contained in the IMF’s ‘undisclosed’ category) could reduce their EUR buying to the benefit of USD but also other G10-peripherals.
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