Euro/dollar to overshoot 1.20, stop before 1.30
The current surge in euro/dollar marks what we identify as the fifth politically-driven currency cycle realignment between the US and Europe since the Second World War. Justified by external payments imbalances and short-term yield/rate differentials it results, in reality, from the much more dramatic political gulf that has opened up between the US and continental Europe.
We see the euro easily exceding $1.20 but no repeat of either the implied $1.30 or $1.40 reached using the Deutschmark as the euro surrogate over the last three decades. The 11ct euro/dollar surge since the start of the year will be reflected in rapidly falling inflation as reduced import costs feed into the system. Markets have not yet fully priced this in.
Past experience from 1985/86 suggests the 14%y/y trade-weighted appreciation of the euro that we anticipate this year will lower area import prices by about 8%. Headine HICP will fall to 1%y/y or less and nominal short rates will fall by considerably more than markets are expecting. The recent change of strategy by the European Central Bank (EZA rpt 527/03May11) gives plenty of room for justifying sharp rate reductions. This is the first of a two-part report.
SummaryAsset Conclusions: Euro/dollar to move above 1.20 quickly, forcing ECB to cut rates sharply, adding to political pressure on Schröder in Germany
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© Graham Bishop
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