Will Euro continue its pain against other major currencies?

The euro is feeling the pain against other currencies as well such as the pound, where policy rates are likely to rise far sooner, and the Swiss franc. 

The odds seem stacked for more dollar strength in the short-term at least. Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said its forecast for 1.10 for euro/dollar in three months is starting to look too conservative although he still feels that this is a modest and short-lived dollar rally and not the start of a substantial long-term surge. 

“Current strength is built around a number of factors. These include the dichotomy in monetary policy between the Fed and ECB. The language of the former continues to become more hawkish; something that we think will have to continue because the Fed is falling behind the inflation curve. In contrast, the ECB continues to argue, probably correctly, that inflation risks are more muted and that it can stay patient about lifting rates. In addition to this, there’s a notable difference in Covid trends. Covid cases are surging in Europe leading to new lockdown pressure and Austria has been forced to return to a pretty full lockdown for at least the next 10 days. The situation in Eastern European countries is particularly worrisome and those countries that are in the eurozone, such as Lithuania, Slovakia, Latvia, Estonia, and Slovenia could find themselves in all sorts of problems as inflation is also surging”, Mr. Steve Barrow said, adding this being said, Covid cases are rising in the US and we may well find, as often in the past, that the surge in Europe is a foretaste of what will happen in the US. Hence, from a currency perspective, the boot could be on the other foot, via a recovery in euro/dollar within a few months. With this in mind, we are still of the view that any slide in euro/dollar to 1.10, or below, will prove temporary.

The euro is feeling the pain against other currencies as well such as the pound, where policy rates are likely to rise far sooner, and the Swiss franc. The latter is important because the Swiss franc strength against the euro usually leads the SNB to conduct a hefty intervention. SNB reserves have nearly doubled since the bank abandoned the 1.20 floor for euro/Swiss at the start of 2015. It is also worth noting that when the SNB intervenes by purchasing euros against the Swiss franc, it later converts a portion of these euros to dollars (38%), potentially creating weakness in euro/dollar. 

However, one thing to note about the current situation is that the world is racked by surging inflation and, in that context, Swiss franc strength may not prove as burdensome as it has in the past. The upshot could be that the SNB is more relaxed about the rise in the currency which allows the franc to rise further against the euro, and, at the same time, we do not see the downward pressure on the euro/dollar that might have come in the past when euro/Swiss was under pressure and the SNB was acting more aggressively. 

This being said, it is worth noting that Swiss inflation is still only running at an annual rate of 1.2% right now and the SNB forecasts that inflation will stay below the 2% level in coming years. “Our call is that euro/Swiss will slide to the parity region and this will likely necessitate SNB intervention which, in turn, could weigh on euro/dollar”, Mr. Steve Barrow said.

The pound is another currency that has gained against the euro; rising to its best levels since just before the Covid-induced volatility of last spring. Higher policy rates in the UK seem likely very soon with the disappointment of November’s decision by the Bank to leave rates unchanged quickly forgotten. However, it is impossible that a divergent rate policy will get the pound very far. The UK appears to be at a greater danger of rising inflation because Brexit has added to the supply-related price pressures emanating from the pandemic. Hence, in real terms, UK rates would rise much compared to those of the eurozone. Much also depends on how continued trade discussions between the UK and EU over the contentious Northern Ireland protocol play out. If things go badly here, leading the UK government to effectively rip up the protocol it could lead to a trade war with the EU; something that would hit the pound very hard. It is widely hopeful that it won’t come to this and ultimately a settlement of this dispute should help the pound. But on a longer-term basis, Mr. Steve Barrow still sees more sterling strength against the (weaker) dollar, not the euro.