At the tail end of a year where the US Dollar index dropped by a double-digit percentage, the Bank of England raised interest rates for the first time in a decade and the European Central Bank begun to eye an exit from the bond market, strategists at Barclays have now set out what they expect 2018 has in store for the currency market.
According to analysts, the US Dollar remains overvalued and should fall gradually throughout 2018 as growth outside of America picks up and other central banks look toward more normal monetary policy.
Meanwhile, the Euro will likely carry an increased risk premium as May’s Italian election approaches, which could cap any further gains for the currency, although the outlook becomes more bullish beyond this point.
The Pound Sterling, on the other hand, could trade “substantially higher” after Brexit is successfully negotiated, although a question mark may hover over its likely long-term value for some time to come.
Further afield Japan's Yen, a long-suffering poster child of unconventional monetary policy, could finally catch a break as inflation stirs and the Bank of Japan tweaks its "yield curve control" program in response.
"The recent hike by the BoE MPC reflects unease with the level of inflation, amid lower trend growth and expectations that the slack in the labour market is eroding."
"The BoE is now expected to deliver a shallow hiking cycle, remaining a source of support for the GBP, otherwise weakened by political risks."
"We forecast GBP to trade substantially higher in our baseline forecast that Brexit is successfully negotiated, but the long-run fair value will likely depend on the outcome of the negotiations."
“The package of modest tax cuts, which appears much more likely, may present some upside risks to our range-bound USD forecast into Q1 18, but we believe it is unlikely to challenge the highs seen at the beginning of 2017 or change the downtrend for the USD.”
“The market continues to price in fewer hikes relative to Fed dots or our own forecasts....Even if changes at the Fed lead to a faster pace of rate hikes, we believe this is not likely to change the terminal rate in the current cycle and as such will aid further flattening in the US yield curve.”
“The Italian election will likely result in a higher risk premium for the EUR in the near term, but we see the ‘Politics of Rage’ more as a medium-term risk for the euro area.”
“The EUR's gains will likely remain supported by solid euro area growth, but much further gains are capped, as the currency is close to fair value. Starting in Q2 18, we expect EUR appreciation to renew on the back of an announcement around sequencing of ECB tightening.”
“Over the course of 2018, we expect a gradual decline in USDJPY after a range-trade into Q1.”
“A move lower in USDJPY is likely to coincide with the weaker USD trend but also reflects JPY-specific factors of extended undervaluation, stretched short positioning, and prospective BoJ policy normalization.”
“We expect a 10bp hike in the 10y target on the BoJ’s YCC in Q3 18 due to above potential growth and synchronized reacceleration in all core inflation measures from mid-2018, followed by an ending of NIRP and additional hikes in 10y.”
“Such a hawkish shift in BoJ policy relative to consensus bolsters our view of JPY appreciation towards 105 by end-2018.”
Above: 2018 exchange rate forecasts. Source: Barclays Research.
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