The Euro will likely recover against the US Dollar through the course of 2017 argues a notes one of the City's leading investment and research houses.
The call for a stronger EUR/USD come at a time of intense downward pressure on the pair with many analysts now eyeing a 1:1 exchange rate being achieved in the near future.
Indeed, the stance taken by Investec could be considered contrarian.
Consensus is for the EUR/USD to be at 1.03 by December 2017.
“We see the USD losing ground against the Euro through 2017. A key driver in late–2017 will be talk of the ECB curtailing its QE buying from 2018 onwards,” says Investec’s FX Strategist Philip Shaw in London.
The main reason behind the higher forecast is the expectation that the European Central Bank (ECB) will announce the start of tapering at the end of 2017.
“Our expectation is that a formal tapering of asset purchases will be an issue that becomes significant for markets towards the end of 2017. We anticipate that the pace of purchases would be wound down over the first half of 2018,” remarked Shaw.
Just tapering had an effect on the USD, pushing it higher when the Fed tapered its own asset purchase programme, so Investec sees the same happening for the Euro.
Part of the pro-EURUSD stance comes from not being very bullish the Dollar half of the pair because they don’t see much more potential for strength.
Investec see the Dollar's rally as 'long in the tooth' and don’t see much more potential left.
They argue higher interest rate expectations are already ‘priced in’ to the exchange rate.
Normally a higher interest rate drives up its domestic currency as it attracts more foreign capital to home shores.
But whilst the Federal Reserve is expected to raise interest rates in the U.S by two or three times in 2017, Investec take the view that this knowledge is already baked into the Dollar.
Eurozone Political Risks Overstated
The great risk to the Euro in 2017 is seen as emanating from the politics of the European Union, rather than the Eurozone economy.
Elections in France, The Netherlands and Germany present opportunities for far-right populist movements to flex their muscles and gain political control.
What they all have in common is a desire to leave the EU, and it is feared that one or more of these, the three largest economies in the Eurozone, could end up leaving.
If not a completed withdrawal from the EU, the rise in negative sentiment may cause a flight from risky assets and home back to safety, which is likely to upset financial markets too.
“The obvious context is the rise of anti-establishment parties and the threat to ‘risk on’ markets. But we are tempted to question this given economic or market reactions to ‘protest’ results,” says Shaw.
Such protest votes include the, “UK’s EU referendum, Donald Trump’s victory and the Italian ‘no’ vote,” and although each caused short-term market volatility, they all also share in common that markets quickly recovered following the initial ‘setback’.
Nevertheless, Shaw does not play down the negative impact another EU member state seeking to exit the bloc would have.
The two most likely countries to face the possibility of a referendum on EU membership are Italy where the 5 Star Party may win an election following the resignation of the Prime Minister Matteo Renzi, and The Netherlands where Geert Wilder’s Freedom Party is rising in the polls and could win the general election there in the Spring.
Investec’s Shaw, however, notes that in both cases there may be considerable legal obstacles to getting the go-ahead on holding a referendum on membership of the EU.
“Whilst the re-pricing of Fed policy has supported the USD, we suspect that an end to ECB QE will see a similar euro revaluation pushing €:$ to $1.14 by end-2017,” said the Investec analyst.