Will the euro weaken?

Stacy Shapiro

The euro has enjoyed a seven year long bull run, but lately the currency has weakened slightly against the US dollar. Stacy Shapiro tries to discover whether this is a blip or a trend

Forecasting currency valuations is a mug’s game, says one currency analyst.

“If I get it right, then it’s my forecast. But if I get it wrong, then it’s not my forecast,” joked George Buckley at Deutsche Bank in London.

There are so many factors that go into a currency forecast that it is difficult to get it right, others agree.

In fact, currency analysts have been forecasting the value of the euro against the dollar and the British pound and come up with several different conclusions over the next three to 12 months.

After a long bull run, the euro fell toward the end of the first quarter against both the dollar and the sterling.

Mr Buckley believes that the pound will improve against the euro in the next 12 months because the downturn in the eurozone has not been as pronounced yet as in the UK. Already, the credit crisis has forced several Bank of England interest rate cuts, but Mr Buckley believes that the European Central Bank (ECB) will cut interest rates even further which will affect the euro.

The dollar will weaken against sterling and the euro, however, because there’s already been a downturn in the US market that happened earlier than in the UK and the eurozone, said Mr Buckley.

As a result, Deutsche Bank analysts expect the pound to drop against the US dollar in 12-months time; for the pound to drop against the euro; and the euro to drop against the dollar, said Mr Buckley.

But not everyone forecasts the downturn in the euro in the next 12 months.

The popular view is that the US market has hit the bottom and will now steady, so the dollar will be stronger against the euro and therefore the dollar will rise while the euro falls, agrees Thomas Stolper, senior global markets economist for Goldman Sachs in London.

“But I’m not sure that’s the case,” said Mr Stolper, senior global markets economist for Goldman Sachs in London.

There’s a theme developing that the euro is at the top of its market, that the worst is over in the US and the US economy is not going into meltdown. The argument continues that the European Central Bank is hawkish and there is some weakness in the eurozone, so it looks like Europe is catching up to the troubles in the US, so therefore there’s no reason to add a premium to Europe and therefore the euro must go down, he said.

“But I don’t quite agree with that,” said Mr Stolper. It’s difficult to believe that the US dollar stability can be maintained when investors are not moving back to the US and most investors are worried about the outlook for the US consumer.

“I think in such a scenario we will see further strength in the euro,” Mr Stolper said. This has happened several times in the past – where investors buy US dollars so the dollar is strengthened, but they do not buy the underlying assets – so they move back to the euro and the euro moves higher again.

“So we need to see real investment in the US” before the euro weakens, according to Mr Stolper.

As a result, Mr Stolper believes there will only be a slight dip in the euro as seen recently. “We might have seen the bottom already – at €0.99, it’s difficult to go much lower,” he said. “Chances are that we’ve seen the bottom already.”
 David Woo, head of global foreign exchange strategy at Barclays Capital, agrees that it’s premature to talk the euro down.

“The USD’s recent appreciation has prompted a belief in some quarters that the euro’s seven-year bull run was coming to an end,” stated Mr Woo in his weekly forecasts in the first week of May. “In our view, as long as America’s real interest rates remain low and China’s demand for commodities stay strong, the scope for further dollar rallies is likely to be limited.”

Nevertheless, in view of the fact that the latest US dollar rally rendered Barclays Capital’s   short-term negative USD forecasts “somewhat unrealistic,” Mr Woo and his colleagues revised their one-month and three-month Euro/USD forecasts.

In fact, Mr Woo and his team have given a range for their three-month forecast of the euro against the dollar by making different assumptions.

“Although the eurozone's expansion has lost momentum, we expect it to weather a US slowdown without having to resort to cutting interest rates aggressively. The euro is also likely to be a major beneficiary of continued strong purchasing power of oil exporters.”

However, “the current USD decline becomes disorderly in nature, affecting the prices of US assets and leading to a volatile sell-off in the USD. The risk of intervention against USD weakness will increase significantly in this scenario but not before even sharper USD depreciation.”