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The EUR/USD currency pair is expected to trade up to 1.30 in the coming year, according to a recent report by ING Bank Research. With bund yields still very compressed (following the ECB’s successful attempt to cool QE taper expectations at the October meeting) and likely to remain compressed until the Italian elections in March 2018, there is room for a possible bund tantrum-like price action and a higher EUR.
The ING economists tentatively expect the ECB to announce an extension of QE by an additional quarter and halving the purchases to EUR15 billion in Q4 2018. However, this should not derail the underlying message: QE is ending, stay long EUR. With the EZ economy doing well (our economists see upside risks to their 2018 growth forecast of 2.2 percent y/y), activity indicators strong and CPI expected to stay around 1.4 percent y/y in 2018 (ie, no risk of deflation) the dissent within the ECB Governing Council to the QE extension should rise (as per the October Meeting Minutes).
The sooner QE ends, the sooner the market will position for the second (not yet priced in) leg of the ECB policy normalization – the rise in the ECB deposit rate (which is now the relevant policy rate given the excess liquidity generated by the QE).
The ECB is expected to stick to the notion of sequencing whereby the deposit rate will be lifted only after the active QE purchases stop and with some delay. Our economists expect a first depo rate hike (by 20 bps) around mid-2019 and the depo rate to reach zero by end-2019. However, as was the case with the ECB QE tapering, the FX market is likely to position for/price in the deposit rate normalization well ahead of the event.
"In our view, this should happen in H2 2018 once it becomes clear that the ECB QE is to stop by the yearend. With the 2-year Schatz yield currently trading at -0.70 percent, it clearly shows that the scope for re-pricing (and thus higher EUR) is immense, causing the second discrete jump in EUR/USD higher and bringing EUR/USD towards the 1.30 level next year," the report added.
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