Euro may not be on a one-way road to parity

March 17, 2015

RTR4SXKP.jpgSigns the euro zone economy may have turned a corner just as many begin to question the timing of a U.S. interest rate hike could soon put a floor under the euro after a 13 percent plunge so far this year.

Major investment banks Deutsche Bank and Goldman Sachs have revised their euro forecasts over the past week and now expect it to breach parity to the dollar sometime over the coming year.

History is not on their side.

The last time the euro fell through parity was 15 years ago, just after it was launched. The common currency has managed to stay above one dollar since 2002 despite two recessions and a sovereign debt crisis that threatened to tear apart the monetary union.

In the short-term, much will depend on the tone Fed Chair Janet Yellen takes at the press conference on Wednesday following the central bank’s policy-setting meeting.

While it is widely expected the word “patient” will be dropped from the statement, opening the door to an interest rate hike sometime soon, Yellen is likely to strongly emphasize a message that future moves will depend on incoming economic data.

The consensus over the last nine Reuters Polls has been for a June hike but the latest survey of nearly 70 economists taken last week  was on a knife’s edge.

The surging dollar, up 10 percent against a basket of six major currencies this year and almost 25 percent since May, has done much of the tightening for the Fed already.

Inflation is steadily dipping while the strong dollar has chipped away at overseas corporate profits and made U.S. exports more expensive in global markets.

On the other side of the trade are expectations the euro zone economy may be turning a corner as evident from a spate of recent data that beat consensus and, in several instances, even topped the highest forecast.

That, coupled with strong inflows into European stocks – Germany’s DAX index hit a record high on Monday – should ideally support the euro.

And as odds mount for the first Fed hike to come sometime after June, the minority view in the latest Reuters FX survey that the euro will rise over the next year might just come true.

Slightly more than a quarter of strategists surveyed two weeks ago expected the euro to gain over the course of a year. The rest predict the currency will continue to weaken.

Rabobank’s senior FX strategist Jane Foley says:

The expectation that the Fed could hike interest rates in the summer is a little overdone. We don’t expect a Fed interest rate hike until December and as such the dollar could find only a little support going into June.

But the pace at which the euro has weakened against the dollar since January has rendered the one-to-twelve month outlook in Reuters Polls obsolete within weeks.

It is currently trading at $1.05, just two weeks after analysts predicted it would end March at $1.12 and fall to $1.08 by the end of August.

Euro 12 month outlook in Reuters March FX Poll

The euro has steadily weakened for months and hit its lowest in 12 years on Wednesday as the European Central Bank embarked on a massive stimulus programme to buy 60 billion euros of mostly government bonds a month until September 2016.

The immediate aim is to weaken the euro so imports get costlier and push inflation, below zero now, higher.

ECB President Mario Draghi is confident the stimulus has already started working and, if proven right, that should lead the economy into a recovery – making it more difficult for investors to sell the euro.

Paul Bednarczyk, head of research at 4CAST and the top currency forecaster in Reuters Polls in 2014 disagrees:

The euro zone has turned a corner but it is going to take a long time to get back up to where it was. As they say, if something falls 50 percent and then goes up 50 percent, then it is not back to where it started. And I think that’s the way you really have to look at some of this European data.

But while the unexpected fall has prompted big forecast revisions, strategists may now be over-estimating how much the euro could slide and for how long.

With additional reporting by Deepti Govind

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