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EUR/USD Ultimately Headed for 1.30 Argues Soc Gen's Juckes

euro exchange rate 6

A stream of positive data and upbeat talk from the continent appears to be stimulating a renaissance in the Euro - but how far can the single currency go?

The Euro is making a comeback.

In early trade on Thursday, the single currency was up 0.35% against the Dollar with one Euro buying 1.1635 Dollars compared with only 1.15 a day ago.

Against the Pound, the Euro was up 0.23% with a quid buying 1.1290 Euros.

The single currency has risen as a result of a mixture of bold 'public relations' from European central banker Benoit Coeure who said the recovery in the Euro-zone is the strongest he has seen in 20-years and hard data from the European Commision who revised up their estimates for growth in 2017 to 2.2% from only 1.7% before - which if true will indicate the fastest pace of growth for 10-years.

The Euro may be impacted by comments from a list of other European speakers from the higher echelons of European Banking as the day progresses, but of special interest will be the head of the German central bank Jens Weidmann speaking in Leipzig, and Bank of France Governor Francois Villeroy de Galhau.

Both are members of the European Central Bank (ECB) governing council which meets regularly to decide the level of base interest rates in the Eurozone, and both - along with Coeure are involved with a controversy relating to the decision-making of the ECB, with implications for the Euro.

Euro-Dollar to 1.30

With broadly positive backdraughts pushing the Euro higher, the next question is how high can it go?

Some analysts, such as Societe Generale's Kit Juckes are extremely bullish, seeing EUR/USD rise all the way to 1.30.

Juckes's bullish view is based on the Eurozone Current Account surplus, which indicates the Eurozone exports more goods, services and actual money than it imports.

Naturally, the imbalance suggests increasing net demand for the Euro since its exports are priced in Euros, and those buying them must convert to Euros to purchase them; this boosts demand for the Euro, lifting its value.

The other reason for SocGen's bullishness is based on the principle of PPP or Purchasing Power Parity.
PPP is a method for determining what is called fair value - which is what the value of a currency 'should' be as opposed to what it is.

If the value arrived at by PPP is the same as the currency's market value then the market has got it right, is working efficiently, and the currency is fairly valued.

Usually, however, this is not the case, and in the case of the Euro the PPP is much higher than the market value, indicating the Euro is undervalued and the market is underestimating its 'real' worth.

The PPP is calculated by taking a basket of goods in one country and comparing the price to the exact same basket in another currency.

For example, say we took a shopping basket of goods in the UK which included milk, bread, cheese, butter and ham, and that basket cost £10.00.

If we then took the same items in Europe and calculated the cost and it came to 9.00 Euros, that would make the PPP exchange rate 10 divided by 9, or 0.90 GBP/EUR.

If the current exchange rate is 1.12 and the PPP is only 0.90 then the fair value by PPP indicates the Euro is actually stronger than the market is actually pricing it at.

The expectation is that over time the market value will move towards the PPP value, so the Euro will appreciate.  

"The trend in Germany's surplus, and the trend in the Eurozone surplus which isn't much less impressive, combine with the euro's PPP undervaluation and the prospect of upward revision to EU Commission economic forecasts this morning, (10 a.m), leaving us pretty firmly bullish of the euro once the current correction/consolidation phase is out of the way," says Juckes.

Indeed, so bullish is Juckes that he sees, "the foundations still being laid for EUR/USD to reach 1.30 this time next year."

As far as the rest of today goes, there is a welter of top Eurozone financiers speaking on Thursday, including Yves Mersch, the Head of the Luxembourg central bank and Vitor Constancio, Vice-President of the ECB who will deliver the keynote address at a Financial Regulatory Outlook Conference.

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European Central Bank Support

Recent reports suggest a group of dissenters within the ECB governing council made up of Coeure, Weidman and de Galhau had opposed what they saw as unnecessary conditions attached by the majority to raising interest rates.  

The crux of the division within the ECB is about whether the European Central Bank should base its decision on 'actual' or 'expected' inflation.

The three dissenters want the decision to be based on expected and the rest - including president Draghi - want it to be based on real inflation data.

It is thought that commentary from the dissenting trio today may shed light on the polemic and this could move the Euro.

So far the first to speak, Coeure has indicated he is satisfied with growth having said it is the strongest in 20-years and appears to have adopted a hawkish stance in line with his reputation as a dissenter - hawkish meaning in favour of higher interest rates.

If the other two also adopt hawkish communication styles - and taken together with the rise in European Commision GDP estimates for 2017 - we could see the Euro continue higher.

The ECB, like other central banks, is basically a 'bank for banks' in that it lends the money to high street and commercial banks which they lend to us. It also can be used by banks to save money in the way we put savings in a 'normal' bank.

The ECB regularly holds meetings to decide the interest it will charge other banks and the decision tends to have a knock-on effect throughout the economy as if it raises interest rates so too will the banks lending to us.

The decision to raise or lower interest rates tends to depend on inflation and growth.

When inflation is getting too high the ECB puts up interest rates to encourage saving and discourage borrowing when growth is low it reduces interest rates to encourage spending and borrowing.

The level of interest rates impacts on the value of the Euro as higher interest rates attract greater inflows of foreign capital drawn by the promise of higher returns; which increases demand for the host currency - in this case the Euro - which rises in value.

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