Foreign Currency Exchange Forecasts Next 6-12 Months: Westpac FX Update

• 2022-2023 exchange rate forecasts from investment bank Westpac - update March 2022
• There is a high degree of uncertainty over near-term trends given the Ukraine conflict.
• The Euro is expected to be resilient with Euro-zone governments taking a proactive stance.
• The peak level of US interest rates is likely to be lower than expected.
• EUR/USD to edge higher to 1.15 by the end of 2023.
• The surge in commodity prices will boost the Australian dollar.
• A slightly more restrained than expected RBNZ stance will limit New Zealand dollar gains.

Peak Fed Funds Rate Liable to Disappoint Dollar Bulls

Westpac notes that there is a high degree of uncertainty over the global outlook and there is the possibility of further short-term net dollar gains on defensive demand.

Overall, however, Westpac expects that the US currency will register net losses during the forecast period.

As far as the US outlook is concerned, the bank does see the need for higher interest rates, especially given inflation trends.

It notes; “Russia’s invasion of Ukraine is more of a threat to US inflation than activity.

In this context, Westpac has increased its short-term outlook for interest rates with three rate increases expected by the end of June.

Over the medium-term however, the bank is less hawkish on Fed policy. The bank expects that inflation pressures will subside over the second half of this year and it expects that earnings in real terms will remain subdued which will hold back the economy and limit the need for further aggressive rate hikes

It notes; “Another key factor justifying a quarterly pace of hikes from July 2022 and our modest 1.875% forecast peak for the federal funds rate in 2023 is momentum in wages adjusted for inflation.”

Overall, Westpac expects a lower peak in US rates which will limit the potential dollar support

Euro-Zone Pessimism Overdone

A second strand of Westpac’s argument is that the Euro-zone economy will perform better than expected.

Although there will inevitably be a negative impact from the Ukraine conflict, the bank considers that markets are too pessimistic over the outlook.

It notes; “The outlook is clouded by a high degree of uncertainty but, to our mind, there are reasons to believe that the out turn for Europe is unlikely to be as bad as market participants have recently feared.”

Westpac argues that economies are dynamic and that there will be policy action to address the downturn.

It considers; “energy infrastructure redevelopment and a push for efficiency across industry will bolster activity and jobs, particularly if the co-ordinated response of European officials continues.”

Overall, it expects that the Euro and Sterling will be able to make headway against the dollar over the medium term; “While recognising that further near-term volatility is likely and an escalation of the conflict a risk, we believe the best baseline view to hold for currency markets is a slow appreciation of Euro and Sterling against the US dollar over the forecast period.”

Westpac forecasts a Euro to Dollar (EUR/USD) exchange rate to find support around 1.10 and edge higher to 1.5 at the end of next year.

Commodity Boost for the Australian Dollar

As far as the Australian dollar is concerned, Westpac expects that there will be further strength in commodity prices and, given that commodities are a key factor in determining the value of the Australian dollar, it expects underlying upward pressure on the currency.

This would set the scene for substantial AUD gains if risk conditions were benign; “Given our new commodity price forecasts, fair value AUD models that do not include a subjective proxy for risk are screaming that it is heavily undervalued.”

The bank, however, notes that the Australian currency moves are also strongly influenced by risk conditions. If fear and risk aversion dominate, the currency tends to lose ground.

In this context, it adds; “The Australian dollar is a ‘risk on’ currency so we have been quite cautious with near term upward revisions to our currency forecasts.”

Westpac also expects that the Reserve Bank will be cautious over raising interest rates.

Nevertheless, it still expects solid gains for the Australian currency; “As risk concerns gradually ease through the second half of 2022, and the RBA begins its own tightening cycle by August, the boost to the AUD from the elevated commodity prices can be more sustained.”

The Australian dollar to Dollar (AUD/USD) exchange rate is forecast to advance to 0.80 at the end of 2023.

Housing Retreat May Limit RBNZ Rate Hikes

Westpac expects that the Reserve Bank of New Zealand (RBNZ) will raise interest rates steadily during the year, especially as inflation pressures within the economy have increased.

Nevertheless, it expects that interest rates will peak slightly below the most recent RBNZ peak forecast of 3.35%.

It notes; “we are not ready to jump on board with the extent of increases that are factored into the RBNZ’s projections. Instead, we continue to forecast that the OCR will rise to a peak of 3% next year.”

Westpac’s primary rationale for its lower forecast is that the housing sector will cool more rapidly than expected and this will limit the need for rate hikes.

It adds; “We have long forecast a cooling in the housing market in response to higher interest rates. However, the pullback in recent months has been sooner than even we expected.”

Westpac still expects net New Zealand currency gains with the New Zealand Dollar to Dollar (NZD/USD) forecast at 0.73 at the end of 2023.

The Canadian dollar is also forecast to make net gains given strength in energy and commodities.

Table of currency forecasts from Westpac covering period 2022-2023.