FX strategists at Rabobank anticipate a decline in EUR/USD exchange rate towards the end of 2023, with a potential shift back to the 1.08 region on a 3-month view.
At the time of writing, the Euro US Dollar (EUR/USD) exchange rate is trading 0.55% lower on the day, at 1.11439.
In her latest brief to clients, Jane Foley, FX Strategist at Rabobank focuses on the anticipated 25-basis points (bps) rate hike at the upcoming ECB policy meeting and the implications for the EUR/USD exchange rate.
Foley contends that market participants largely anticipate the rate hike, and attention is shifting towards the prospects of the subsequent September policy meeting.
The strategist expresses the prevailing sentiment, "The outcome of next week’s ECB policy meeting is considered by most markets participants to be a done deal. A 25-bps rate hike has been baked into the price for some time," says Jane Foley, FX Strategist at Rabobank.
Foley presents that the consensus regarding another 25-bps rate move during the September meeting is wavering.
The "house view at Rabobank" suggests that the ECB may instead keep rates unchanged in September, aligning with Foley's perspective.
"However, confidence in such a move has started to waver and it is our house view that the ECB could choose to leave rates unchanged in September," she adds.
The upcoming decision will be influenced by the nature of economic data reported between now and September.
Foley acknowledges that while core inflation in the Eurozone persists, weaknesses are emerging in other sectors of the economy.
Highlighting the importance of interest rate differentials, Foley asserts these have been a significant steer for the Euro-Dollar direction in 2023.
"Interest rate differentials have played a huge part in driving the EUR/USD exchange rate this year," says Foley.
Following the soft US CPI inflation data last week, market expectations solidified that the Fed will reach its peak policy rates post a predicted 25 bps hike next week, causing the USD exchange rates to broadly fall.
"The release of weaker than expected US CPI inflation data last week cemented market expectations that the Fed will reach its peak policy rates after an anticipated 25 bps hike in rates next week. As a result, the USD lurched lower across the board," she adds.
Over the coming months, the ECB is also expected to reach its peak policy rate, which could potentially weaken the EUR.
Foley highlights that revised June CPI inflation data for the Eurozone indicates a faster than initially projected acceleration in core inflation.
Recent remarks by ECB officials suggest these inflationary pressures may have topped out.
"Earlier this week, the ECB’s Knot suggested that core inflation appears to have ‘plateaued’," says Foley.
This signals a potential shift in ECB's policy stance beyond July, which was previously anticipated to continue on its tightening path.
Foley's analysis also incorporates the impacts of the Eurozone's broader economic context.
The Eurozone economy contracted by 0.1% quarter-on-quarter in Q1 this year, signifying a technical recession.
While the services sector has outperformed manufacturing, a second consecutive monthly fall in the Eurozone services PMI in June to 52.0 signifies continued expansion, but at its slowest pace since January.
The struggling recovery in Chinese economic growth has adversely impacted Germany's large industrial sector, and both consumer and business confidence remain below long-term averages.
The combination of these factors paints a rather bleak economic outlook for the Eurozone in the upcoming months.
According to Foley, this aligns with a recent FT report;
"The backdrop of a weak Eurozone economic outlook in the months ahead sits comfortably with an FT report suggesting that the ratio of puts to calls tied to the blue-chip Euro-Stoxx 60 index has risen, as investors seek protection from downside risks," she adds.
In light of these conditions, Rabobank recently revised up its near-term exchange rate forecasts for Euro against the U.S. Dollar.
However, expecting that the ECB is also close to reaching its peak in policy rates, analysts at Rabobank anticipate a decline in EUR/USD towards the end of the year, with a potential shift back to the 1.08 region on a 3-month view.
Francesco Pesole, FX Strategist at ING, notes that the current slip of EUR/USD back to the 1.1200 level still leaves it approximately 2.5% overvalued according to ING's short-term financial fair value model.
This overvaluation results from a re-widening in the two-year EUR/USD swap rate gap, now veering back to pre-US CPI levels. The Eurozone economic calendar, and its implication for the exchange rate, is something that Pesole emphasises.
"We think EUR/USD is more likely to ease back from these levels than jump back higher. A test of 1.1100 in the coming days would be in line with a re-connection with its short-term fair value," says Francesco Pesole, FX Strategist at ING.
The analyst sheds light on the key drivers of the current position of the euro. In addition to the swap rate gap, Pesole points to the upcoming Eurozone consumer confidence figures for July, which are expected to mirror those of last month, as another factor to consider.
"Today, the eurozone calendar includes consumer confidence figures for July, with consensus expecting a virtually unchanged read from last month," he adds.
The Eurozone's final core inflation rate, which was recorded at 5.5%, slightly higher than the preliminary 5.4%, also figures into the evaluation of the EUR/USD valuation.
Furthermore, Pesole highlights recent media reports that indicate a softening in the tone on forward guidance from the Governing Council members as they plan a 25bp hike next week. This is seen as a signal that concerns over inflation may have been somewhat alleviated.
"Yesterday, the eurozone final core inflation printed 5.5% versus the preliminary 5.4%. Still, media reports that Governing Council members are planning to soften their tone on forward guidance as they hike by 25bp next week suggests – as also hinted in recent remarks – that concerns on inflation may have eased slightly," says Pesole.