Thought of the day
08.09 - Has the euro's rise gone far enough?
Currency traders focused on the hawkish elements of ECB President Mario Draghi's comments this week – including an upbeat assessment of the Eurozone economy and a hint that an announcement on the tapering of bond purchases could come at the central bank's October meeting. This interpretation helped push the euro above USD 1.20, taking the currency's rise for the year to 15%.
But we believe the currency market may have overreacted for a number of reasons:
- Draghi emphasized that the euro's rise was a "source of concern," suggesting that it had the potential to suppress inflation. Further appreciation could prompt more concerted verbal intervention or even move policy in a more dovish direction.
- The ECB staff cut their inflation projections to just 1.2% in 2018 and 1.5% in 2019, with these estimates being based on a EURUSD exchange rate of 1.13 this year, and 1.18 next year and 2019. Fixed income traders appear more focused on this, and yields on the 10-year Italian bonds initially fell eight basis points.
- And when a tapering announcement comes, we expect it to be presented in the most dovish terms, as an extension of the current bond buying program – albeit at a slower pace.
So, we don’t expect further significant euro appreciation, and our 12-month forecast for EURUSD is 1.20. Stabilization in the euro would support corporate earnings and our overweight Eurozone equities versus UK equities.