The following is an extract from our quarterly outlook, published 23rd June 2014. I’ve included a table of forecasts at the foot of the blog.
We went into 2014 relatively bullish on the euro. The interest rate angle to the single currency was a lot more complex than many were making out. It was not a case of a rate cut would automatically lead to a lower currency, as proved to be the case with the November 2013 easing. There were other forces at play, notably the repatriation of funds ahead of the ECB asset quality review, but also the strong performance of European asset markets in general, especially peripheral bond markets.
More recently, the combination of measures announced by the ECB in June did serve to bring down short-term funding costs and naturally the euro has underperformed most major currencies both ahead of and after the event.
For the second half of 2014 though, asset market performance will still be a dominant force. The policy measures announced by the ECB are not likely to have a major negative impact on the currency. Furthermore, the liquidity provision via TLTROs is not due to start until September. If peripheral markets continue be characterised by comparatively low yields, this would mean that we see modest, if any euro depreciation vs. the dollar in the third quarter.
We don’t expect the ECB to undertake QE in the traditional sense of the word. It is likely that they will undertake some further programs in relation to asset backed securities as a means to attempt to lower borrowing costs, but there is no big bazooka. The eurozone’s deflation risk is largely structural, borne from the build-up from internal imbalances that cannot be cured by the usual means available outside a currency union.