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CBA Currency Forecasts: Euro 1.2600 Year End

Posted by Joseph Trevisani on Jul 11, 2013 2:13:00 PM

Commonwealth Bank of Australia


Adjusting forecasts to central bank guidance

A stronger US labour market and clear forward guidance from the Fed, ECB and BoE, necessitate an adjustment.


We continue to forecast a stronger USD as the likelihood of Fed tapering draws nearer and US bond yields lift.


AUD/USD near‑term forecasts are revised marginally lower. But longer‑dated AUD/USD forecasts are lowered more.


Vocal central banks

Another strong US labour market report as well as fresh clear forward policy guidance from the Fed, ECB and BoE over the last couple of weeks requires an adjustment to our currency forecasts.


The impending divergence in monetary policy cycles between the Fed, as it signals the end of its quantitative easing cycle, and the ECB, BoE, BoJ and RBA as they remain firmly in their easing cycles, underpins our firmer USD forecasts; just as it did when we undertook our previous adjustment to our currency forecasts in late May 2013 (chart 1).

Continued USD strength

We have made some further upward revisions to our longer‑dated USD forecasts because that the Fed has made the outlook for US monetary policy a little clearer. The USD is set to continue its upward‑trend driven by: (a) the monetary policy cycle divergence, (b) higher US real ten‑year bond yields; (c) a narrowing US current account deficit to 2.7% of GDP; and (d) reduced USD diversification by emerging market central banks (chart 2 & 3).


Higher US yields discourage USD diversification because holding USDs becomes relatively more attractive. Reduced global inflation pressures generate easier monetary policies in the emerging markets and reverse upward pressure on emerging market currencies. Consequently, reduced foreign exchange intervention followed by USD diversification occurs by the emerging market central banks. The net result is less downward pressure on the USD (chart 4).

AUD lower for longer

We have lowered our longer‑dated AUD forecasts and made some minor downward adjustments to our near‑term AUD forecasts. The reasons behind our decision to lower our AUD/USD forecasts are similar to the reasons why we lowered our AUD forecasts in late May 2013 ‑

(a) A stronger USD as indicated above; (b) lower global inflation pressures reflecting below‑trend global economic growth and increased commodity supply is applying downward pressure to Australia’s terms of trade; (c) China’s economic growth continues to moderate and this is reducing the pace of Asian GDP growth. Asian currencies and the AUD remain under downward pressure (chart 5 & 6).

The extent of the recent inter‑bank policy tightening measures undertaken by the PBoC has been reduced. But it is clear the Chinese authorities want to see lower credit growth (total social financing) in the economy and are moving towards deregulatory reforms that take time to foster more rapid GDP growth in the broader economy.

(d) Reduced foreign buying of Australian government bonds has altered the demand‑supply dynamics that helped keep the AUD/USD higher for longer than was expected given the levels of Australia’s terms of trade and interest rates. The latest available March 2013 data indicates that net foreign buying of A$ bonds has declined to around $2.3 billion per quarter from almost $20 billion per quarter twelve months ago (chart 7).

Australia’s AAA sovereign rating and yield advantage persists. But it is quite likely reduced net A$ bond buying will continue over the next twelve‑to‑eighteen months as participants become more drawn to higher US real yields, and the downside risks to Australia’s economy are worked through. The downside risks to the Australian economy are related to the transitionary phase the domestic economy will undertake; away from mining investment and towards net exports, residential investment, household consumption and non‑mining business investment. Our old and new AUD forecasts are in the table below.


Modest EUR depreciation

At its 4 July policy meeting, the European Central Bank (ECB) took the unprecedented step of providing some forward guidance, indicating the key ECB interest rates will remain “at present or lower levels for an extended period of time”.

The on‑going contraction in the Eurozone economy, which as we enter Q3, makes it the 8th consecutive quarter of negative GDP growth, stands in stark contrast to the US economy, which has entered its 17th consecutive quarter of GDP growth. The Eurozone‑US two‑year bond spread is reflecting the divergence in economic growth and monetary policy cycles between the Eurozone and the US (chart 8)

The main reason we don’t have a lower EUR/USD forecast is because the Eurozone’s current account surplus, at 1.6% of GDP, is pushing record highs. This is generating support for the EUR/USD (chart 9). Our old and new EUR forecasts are in the table below.


Further GBP depreciation

At its 4 July MPC meeting, the Bank of England (BoE) stated that “the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.” It is quite likely the BoE will provide explicit forward guidance on lower interest rates when it meets on 1 August 2013.

The combination of the divergence in monetary policy cycles between the Fed and BoE, negative UK real interest rates and a large UK current account deficit (equivalent to 3.9% GDP) remain the reasons behind our lower GBP/USD forecasts (charts 9 and 10). We have not made any adjustments to our near‑term GBP/USD forecasts.


Moderately lower NZD

While the New Zealand economy continues to do well, and we envisage the RBNZ will be one of the first major central banks to lift interest rates, it will be difficult for the NZD/USD to buck the trend of a firmer USD (chart 11). We have subsequently lowered our NZD/USD forecasts. The old and new NZD forecasts appear in the table below.


Continued depreciation in JPY

We continue to see upside in USD/JPY driven by both a firmer USD and the collapse in Japan’s current account surplus from a 15 year average of 3.1% of GDP to less than 1.0% of GDP. Our projected pace of USD/JPY upside has been reduced to reflect the market’s reduced enthusiasm about the BoJ’s policy. Our old and new JPY forecasts are in the table below.








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