EUR/USD and EUR/GBP for the long term perspective?

Robert Wood, Chief economist at Berenberg Bank, on EU economy and Euro

The biggest event for the markets this month is certainly January 22 meeting of the ECB, at which Mario Draghi has unveiled a new stimulus program. But whether QE really has any lasting effect on an economy at all is still a big question on the Continent. Do you expect any positive impact on the economy after the announcement?

I do expect a positive impact on the economy, since the experience of the US and UK over the past few years shows that QE works. It reduces bond yields, cuts exchange rates, improves confidence and lowers spreads. Moreover, it automatically results in stronger growth. The UK and US are growing solidly right now, whereas the Euro zone is not. Thus, for those reasons I expect do ECB’s sovereign bonds buying program to work.

The big risk, I believe, is rather not that quantitative easing does not work, but the ECB just is not doing enough of it instead, in deference of the Bundesbank hawks. The big lesson from the past experience for the officials is to show they are committed rather than are doing QE under pressure.

Governing Council member Ardo Hansson said that the European Central Bank should slow its rush toward fresh stimulus as current measures haven’t had time to work and challenges including Greece’s political crisis make buying government bonds difficult. Will you agree with it? And do you consider this is the right moment to turn to QE program?

I believe that it, this is the right moment for the QE, since inflation in the Euro zone is well below the ECB’s target, even if we exclude energy and food prices, which are tracking down heavily just now. Core inflation is mildest below the legal mandated target of close, but less than 2%, and there is a very little prospect to inflation returning to that figure any time soon, even with a little bit of help from oil prices. The challenge is that falling oil prices and negative inflation continue to weigh on inflation expectations in the Euro zone, raising the risks of a more persistent deflation.

What will be the major headwinds for Euro throughout Q1 2015?

Obviously, first of all the ECB’s decision of asset-purchase program dominates, and what we have seen in previous episode is that the large scale QE pushed down the exchange rate. Most of that is already priced in to the Euro, but we believe it will wait a bit further, due to the concerns of a very low inflation rate.

Beyond that, if ECB’s actions work then it should automatically help support the exchange rate, rather than devaluate in uncontrolled way. What, for example, we observed in the US and UK, whose currencies are relative to the Euro since they started down the QE. Thus, the key drivers for the Euro are political risks in Greece and forthcoming ECB’s decision of stimulus program throughout Q1.

What are your forecasts for EUR/USD and EUR/GBP for the long term perspective?

We forecast the EUR/USD to be around 1.20 by the end of 2015 and the EUR/GBP to be at 0.76.