‘Draghi's promise' to weaken the euro

Main forecast changes part I

• Mario Draghi’s ‘promise’ of further ECB easing in June could very well be the turning point for the euro and in general we have pencilled in more euro weakness to our FX forecast as it now appears more likely that the ECB will actually deliver further monetary policy easing in response to low inflation.

• In terms of EUR/USD, the soft rhetoric from the ECB has indeed eased medium- and long-term upside risks to EUR/USD significantly. In addition, we note the downside risks to the US economy have faded following a temporary dip at the beginning of the year and as US recovery is expected to gain pace in coming quarters so Fed tapering will remain on course. We expect the Fed to hike rates in mid-2015 in line with the Fed’s own projection. However, we believe the risk is skewed towards earlier tightening and, as the market is currently pricing in the first hike in autumn 2015 and for prices to increase only very gradually thereafter, we expect a repricing of the Fed funds curve to take place over coming quarters. Hence, we still see potential for a cyclical downtrend in EUR/USD through a trend in relative rates and we now target EUR/USD at 1.35 in 3M (previously 1.40), 1.32 in 6M (previously 1.36) and 1.28 in 12M (previously 1.30).

• We stick to our view that EUR/NOK will continue to edge lower over the next 12 months. However, given our view that the ECB will ease monetary policy in June, that Norges Bank will start to hike rates in Q2 15 and the recovery in the Norwegian economy, we have pencilled in a slightly more negative profile for EUR/NOK. We now forecast that the cross will drop to 8.00 (8.15) in 3M, 8.00(8.10) in 6M and 7.85 (7.95) in 12M. An extra supportive factor for the NOK going forward would be if Norges Bank (due to the rising before-oil deficit) starts purchasing NOK in the market to fill the ‘funding gap’ instead of purchasing foreign currency on behalf of the Pension Fund Global (Petroleum Fund) which has been the norm for many years.

• The SEK is likely to come under some pressure going into the Riksbank meeting in July, but it will not be a major drag given what is already priced in. Furthermore, M&A-related flows will ebb out and cancel some of the help for SEK that we have seen recently. Hence, we still see risks skewed to the upside in the near term for EUR/SEK and target the cross at 9.10 in 1M. The global and the Swedish growth outlook are medium-term supportive factors for the krona and we have kept our six- and12-month targets unchanged at 8.95 and 8.75, respectively.

Main forecast changes part II

• The combination of the BoE moving towards the first rate hike and the prospect of euro weakness on the back of ECB easing means we expect EUR/GBP to move lower over the coming year. Given that we now expect more aggressive easing from the ECB, we have pencilled in slightly more sterling strength over the next 12 months. We now expect EUR/GBP drop to 0.80(0.81), 0.79(0.80) and 0.76(0.77) on three-, six- and 12-month horizons. In particular, on a 12M horizon, we expect sterling to appreciate against the euro as the BoE is way ahead of the ECB in the monetary policy cycle and as an expected stronger US dollar tends to support sterling.

• We have kept our USD/JPY forecast unchanged and still target USD/JPY at 106 in 3M, 110 in 6M and 114 in 12M. However, we highlight that weak economic growth has increased the probability of the BoJ easing earlier.

• In the short run, further ECB easing is likely to cap EUR/CHF upside and we have consequently lowered our 3M forecast to 1.23 (1.24). In the next six-12 months, however, we still expect EUR/CHF to gradually edge higher towards 1.24 (before 1.25 and 1.26), mainly driven by a reversal of safe-haven flows and an increase in Swiss portfolio investments abroad.

• The positive risk sentiment in global markets is boosting most of the EMEA currencies. In particular, the Turkish lira and the South African rand are benefiting from the risk-on mood among other EMEA currencies. Hence, while political risk has declined considerably in Turkey and positive risk sentiment is intact, the Turkish lira could gain further. In this respect, we have revised our USD/TRY short-term forecast in a more positive direction. The same applies for the South African rand on which we have also become more positive on the short-term horizon of three months. Regarding CEE, we have not made any big changes compared with last month. We have revised up our HUF forecast slightly as the economy is showing signs of a faster-than-expected recovery.