EUR Forecast at 1.15

EUR Forecast at 1.15

A global growth slowdown, and even recession in some regions such as Europe, is likely to develop in the first half of 2012, in our view. Morgan Stanley economists are projecting a significant economic underperformance of developed market economies. From a currency perspective, we believe that the effectiveness of the relative monetary policy response to the anticipated slowdown will be important, with areas that have a well-functioning monetary policy transmission mechanism likely to see currency appreciation. Meanwhile, in areas where money multipliers are challenged, we expect currency underperformance. In the eurozone, where we expect the economic slowdown to be most severe and the policy measures least effective, as a result of the deleveraging process, we have turned more negative from a currency perspective.

Indeed, we have revised our EUR FX forecasts significantly lower for the coming year, not just against USD, but on many of the crosses as well. We are now projecting EURUSD declining to 1.15 by 4Q12, from our previous forecast of 1.20. This downward revision reflects our view that ECB policy will be playing a greater role in Europe, with increased liquidity weighing on the EUR over the medium term. The agreement regarding the fiscal compact in the eurozone has been met with enthusiasm by the ECB, which will once again raise optimism that such an agreement could also result in a more flexible approach from the ECB.

We also still expect GBP to remain under pressure, especially as the BoE is likely to extend QE, in our view. Indeed, our UK economics team projects that £50 billion of QE will be announced at the February MPC meeting. We also highlight that the latest data reveal a net overseas investor outflow from the UK gilt market in December, consistent with our view that there has been a slowdown of safe haven flows into the UK, leaving GBP vulnerable to the deteriorating economic data. This slowdown in overseas investor inflows coincides with the ECB’s three-year LTRO, suggesting that the recent stabilization in European bond markets is resulting in a slowdown of GBP-supportive safe haven flows. Hence, we expect GBPUSD to come under renewed pressure, although EURGBP is forecast to move lower as a result of the weakness of EUR.

We expect the outperformance of the high-beta currencies, as a result of the early year optimism, to be extended in the first half of the year, fuelled by market expectations of additional global liquidity. Both the US and China are also expected to address the prospect of a global economic slowdown in 2012 with pro-growth policies. In this regard, we expect AUD to remain well supported in the first half of the year, before a setback takes hold in 2H12.

Overall, we continue to expect USD to be the outperformer in 2012, along with JPY. The US’s more pro-growth policy suggests that USD will remain supported. On a trade-weighted basis, we anticipate a 5.5% appreciation of USD in 2012.
The Scandinavian currencies, which had previously been seen as a safe haven from the developments at the periphery of Europe, are also expected to come under pressure as a global slowdown and recession in Europe unfold in the coming months. We expect both SEK and NOK to depreciate in 2012.