Currencies | Feb 17 2010
By Chris Shaw
Greece and its debt problems have dominated the news for the euro-zone over the past month, Danske Bank pointing out these fears have increased the risk premium being attached to the euro by those involved in currency markets.
But it isn't Greece specifically that is the big issue in Danske's view as the Greek economy only accounts for around 2-3% of euro-zone GDP, rather the situation has become more a systematic one as concerns have also risen regarding the financial stability of other nations in the group including Portugal, Ireland, Italy and Spain.
This in turn has seen government bond spreads widen in these markets, so putting pressure on the euro as the risk premium associated with the currency has increased to more than 4%, an outcome greater than Danske Bank had factored into its forecasts.
In terms of Greece specifically Danske suggests the pressure has eased somewhat in recent days as the European Community offered to support the nation's economy, but this hasn't eased the pressures on the euro as there are few clear details outlining the form any support will take.
The big issue in Dankse's view is the situation in Greece is a natural consequence of the euro-zone economic model, as while monetary policy has been centralised fiscal policy continues to be decentralised. This means a political solution will need to be found to the crisis.
Danske Bank expects this will occur without any member defaults or euro exits, so on a three to six month timeframe it sees the risk premium on the euro coming down, though until a credible solution for Greece is found the currency will remain under pressure.
Given the economic issues speculators have been quick to jump on the euro weakness and put additional pressure on the currency, but Danske Bank's view is the selling has not only been by this end of the market.
Recent data show the euro-zone is underperforming the US and so lifting fears the region decouples from the global economic recovery, an outcome that would likely postpone any tightening of interest rates by the European Central Bank (ECB).
To reflect this Dankse now sees both the ECB and the US Federal Reserve lifting rates more or less simultaneously in the December quarter of this year, an outcome it suggests removes a more preemptive ECB as an argument for why the euro may gain on the US dollar.
To reflect this, Danske Bank has cut its forecast profile for the euro against the US dollar, the changes being most significant in the shorter-dated end of its model. On a 3-month basis Danske now forecasts a euro/US dollar rate of 1.35 against 1.46 previously and in 6-months it now expects a rate of 1.38 against 1.43 previously. There is no change to its 12-month forecast of a rate of 1.40.
In contrast to short-term weakness against the US dollar, Danske expects the euro may trade a bit higher against the British pound in the short-term as the Bank of England (BoE) is now seen as unlikely to lift rates before early in 2011 given the need to further repair balance sheets in the UK economy.
Given this, Danske is now forecasting EUR/GBP rates of 0.86 in three months, 0.85 in six months and 0.82 in 12 months. There is no change to its view on a purchasing power parity basis the pound is one of the most undervalued of the G10 currencies, while the euro is the most over-valued.
Elsewhere in forex markets Danske Bank expects after recent weakness driven by a deteriorating risk appetite and falling commodity prices, the Australian dollar will break higher against the US currency in coming months, especially as relative monetary policy should be supportive given expectations the Reserve Bank of Australia (RBA) will hike further in coming months but the Fed won't move until late in 2010.
These moves by the Fed should generate a narrowing of the interest rate differential between Australia and the US and so put some downward pressure on the Aussie dollar, so while the trend in coming months is higher Danske doesn't expect the Aussie will hit new highs against the greenback. Its forecasts are for AUD/USD rates of 0.91 in three months, 0.94 in six months and 0.88 in 12 months.
Danske Bank sees a similar scenario playing out for the New Zealand dollar against the US currency as monetary policy tightening by the Reserve Bank of New Zealand (RBNZ) is expected well before any similar moves by the Fed, but once the Fed embarks on a similar path this will likely to signal a turnaround in the current trend of a stronger Kiwi dollar.
Its forecasts indicate such an outlook as while Danske predicts a NZD/USD rate of 0.71 in three months' time and 0.75 in six months, Danske Bank is forecasting a 12-month rate of 0.68.
