Euro exchange rates forecasted to head yet lower as a likely further interest rate cuts will further erode yield

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Published on Monday, 09 July 2012 12:34

Written by Sam Coventry

International Money Transfers at our sister site

Deutsche Bank lower forecast for euro dollar exchange rate to 1.2.

Last weeks action on interest rates by the European Central Bank has eroded much of the yield support behind euro exchange rates. (For more comprehensive FX forecasts please see our IMT site, free access issued via this Facebook pathway). 

Even though the ECB disappointed other markets by “only” cutting interest rates, analysts believe the cut in the deposit rate to zero is very significant for FX.


According to Bank of America Merrill Lynch Global Research:

"The ECB has for the first time done something more “unconventional” than the other major central banks. The deposit rate floor is now lower than the BoE, Fed and BoJ at 50, 25, and 10bps respectively.

"This implicitly signals a greater ECB easing bias and a desire for a lower EUR. Second, the euro has dropped down the currency yield ranking from fourth to second lowest-yielder. Only the Swiss franc now has lower funding costs, and FX carry models are likely to further increase funding positions in the EUR, mostly to the benefit of the USD."

As such, further cuts to rates at the ECB will further hamper the the euro (Currency:EUR), and such a cut is currently forecasted by Bank of America Merrill Lynch Global Research:

"We expect one more rate cut from the European Central Bank toward the end of 3Q (refi to go to 0.50%; marginal lending to 1%). There will be no LTRO for now, rather fine-tuning of collateral requirements, Also, the ECB is expected to act as an agent for EFSF, with conditionality to apply."

Backing the theme of a weaker euro moving forward is a weekly FX note from Deutsche Bank who lowered their forecast for the euro dollar exchange rate:

"We think EUR/USD will reach 1.20 over the summer but are more ambivalent over the wider USD trend."

ECB Head Mario Draghi made a rather dovish assessment of the economic outlook, opening the door for another 25bp cut in the refi and marginal lending facility rates.

Draghi underlined that downside risks to economic activity had materialised across Euro area countries amid renewed tensions on sovereign markets, dampening global demand and rising energy prices.

"Against this backdrop, the ECB forecasts inflation falling below 2% in 2013, and maybe earlier. We estimate the ECB will cut the main refi rate by another 25bp to 0.50% around the end of 3Q and the marginal lending facility by 25bp to 1.0%, given our projections of a 0.7% contraction in GDP this year and zero growth next year with inflation falling to 1.5% on average in 2013 (and below 2% in 4Q). However, we do not expect the ECB to bring the deposit rate into negative territory at that time," say Bank of America.