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Euro on the ropes and facing a major fight

Markets were caught completely off guard last week by the surprise decision of the Swiss Central Bank (SNB) to abandon its currency cap of CHF1.20 against the euro.

It is widely seen as a pre-emptive move by the SNB ahead of the expected announcement of a large QE government bond purchase programme by the ECB later this week.

The SNB obviously decided that such a move by the ECB would make it very difficult to continue to defend its currency ceiling, something it had said only last month that it would enforce with the utmost determination.

The SNB has been buying ever larger quantities of euro, increasing the size of its balance sheet to unprecedented levels relative to the size of the economy.

The SNB move had a big impact on markets, pushing the euro down through long standing, major support levels. Against the dollar, it fell below the key $1.18 support level, declining to $1.15, its lowest level since 2003.

The major support at 78p against sterling also gave way, with the euro falling close to 76p, the lowest rate since 2008. It also lost considerable ground against the yen.

Unsurprisingly, the key focus for markets this week is Thursday’s ECB meeting. The consensus is that the Governing Council will decide to launch a large QE programme, amounting to upwards of €500bn.

While QE is widely expected, there remain some possible points of contention. For example, there is the issue of risk-sharing between the ECB and sovereign central banks in terms of the bond purchases, as well as the question of the criteria to be met for debt to be eligible.

The main interest for markets will be on the size of the programme and any disappointment on this front could see some of the recent euro losses reversed.

Even so, with key support levels having given way in the past week, the prospects look bleak for the euro and can be expected to weaken further this year. The political uncertainty in Greece, negative inflation, weak economic data and policy easing by the ECB are all putting pressure on the single currency.

Meanwhile, the much more positive outlook for the US and UK economies, and likely rate hikes from the Fed and BoE in 2015-16, also suggest that further gains are likely by the dollar and sterling against the euro.

We see the euro falling to $1.10 and 73p versus sterling during 2015. Indeed, if the expected interest rate hikes by the Fed in 2015/16 prove more aggressive than currently anticipated by markets, then the EUR/USD rate could head towards parity in the next couple of years.

The euro’s depreciation is of major benefit to economies such as Ireland that do a lot of trade with countries outside the eurozone. Irish exports to the US and UK gain in competitiveness as a result of the weaker euro. The Irish tourism industry will benefit also.

Meanwhile, one strong technical forex support that is holding is the $1.50 level for sterling against the dollar. Sterling has rarely traded below this level in the past 30 years, with $1.40 representing the absolute floor for the rate over this timeframe. The last time sterling fell much below $1.50 was for a brief period in spring 2010.

Our view is that if expectations of even modest rate hikes in the UK remain intact, the $1.50 support level should hold for sterling. Indeed, US rate hikes should strengthen the view that UK rates will also have to rise eventually.

One risk for sterling, though, is an outcome to the UK general election that markets view as negative for the currency. There would be concern, in particular, if there was increased uncertainty about the UK’s membership of the EU following the election.

Article Source: http://tinyurl.com/kbwqb42

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