G10 FX Forecast Revision - Q3 2017

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The main news story in the currency markets this year has undoubtedly been the sharp depreciation in the US Dollar against every major world currency. 

The Federal Reserve raised interest rates again in the US at its June meeting and remains the only G10 central bank engaged in a full on hiking cycle. However, expectations for a slower pace of Federal Reserve rate hikes has weighed on the currency and the market is now not pricing in another increase in the fed funds rate until as far out as March 2018. President of the US Donald Trump has also provided little assistance to the greenback. The Trump Administration has so far failed to force through any sort of meaningful policy changes and his pledge to ramp up spending and cut taxes looks more and more unlikely. As a result, the US Dollar has sold-off sharply against every G10 currency so far in 2017 and the US Dollar index has lost almost 10% of its value in a little over seven months (Figure 1)

Figure 1: US Dollar Index (August '16 - August '17)

1.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

Away from the US, the European Central Bank has hinted it could finally begin winding down is quantitative easing programme, two-and-a-half years after it was first launched. The market is now earmarking the ECB’s September meeting as a realistic opportunity for policymakers in the Eurozone to announce it will soon be tapering its asset purchases. By contrast, the Bank of England looks increasingly unlikely to hike interest rates this year following a slowdown in inflation in the UK. With the outcome of the Brexit negotiations not expected to be known for some time, Sterling is likely to be driven predominantly by expectations for future monetary policy.

Meanwhile, oil prices have begun to initiate a rebound after falling to a seven month low in June following a build-up of oil inventories. This has helped support the oil dependent Norwegian Krone and Canadian Dollar, the latter of which was buoyed by the Bank of Canada’s first interest rate hike in seven years in July. With political risk taking a back seat we think that the best performing G10 currencies during the remainder of the year will be those whose central banks are closest to beginning the long awaited process of monetary policy normalisation.

 

 

US Dollar (USD)

The US Dollar has had a very difficult 2017, slumping to its weakest position in trade-weighted terms since May 2016 in August (Figure 1).

Evaporating hopes that the Trump administration will be able to force through any sort of fiscal stimulus in the US this year and a pushing back of the timetable for Federal Reserve interest rate hikes has caused the currency to relinquish approximately 10% of its value so far this year.

Trump’s pledge during his election campaign to increase government spending on infrastructure by $1 trillion are unlikely to come to anything in our view, while the chances that he’ll be able to enact any sort of meaningful tax cuts in 2017 are now materially lower. The IMF has even cut its outlook for the US economy, removing its assumption that Trump’s plans to cut taxes and ramp up spending would increase growth.

Expectations for a slower than expected path of interest rate hikes by the Federal Reserve this year has also attributed to much of the softness in the Dollar, even though the Fed hiked interest rates again at its June meeting. The FOMC increased their main interest rate by a further 25 basis points to a range between 1-1.25%, their third consecutive quarterly increase in the fed funds rate. Chair Janet Yellen has struck a fairly optimistic tone on the overall health of the US economy during her recent press conferences. Policymakers continue to overlook the relatively soft performance in the US in the first quarter of the year, which it has deemed as temporary. This view was justified by the 2.6% annualised growth recorded in the three months to June, a marked upgrade on the first quarter’s downwardly revised 1.2%.

Janet Yellen has also sounding a hawkish note by referring to the “very strong” labour market, while claiming economic activity had been rising moderately so far this year. The recent jobs reports out of the US have been fairly mixed, although sufficient in our view to warrant higher interest rates. The US economy added 209,000 jobs in July. The three month moving average of nonfarm payrolls is now back around the 200k mark, having fallen to its lowest level since July 2012 in May. The unemployment rate has continued to drop and is around the level deemed as full employment by the Fed. Wage growth has, however, been fairly sluggish and slow to react to the recent decline in the jobless rate (Figure 2).

Figure 2: US Nonfarm Payrolls (2013 - 2017)

2.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

However, the Dollar sold-off sharply following the July meeting after the Fed changed its rhetoric on inflation, claiming that the headline rate was now running “below” 2% compared to the “somewhat below” that was included in the previous statement. Inflation in the US has also been on downward trend in the past few months, although the Fed has again attributed this largely to one off factors including a steep drop in the cost of mobile phone services. The headline rate of consumer price growth came in at just 1.7% in July (Figure 3), while the core measure remained at 1.7%, its lowest level since early 2015. The Fed’s preferred measure of inflation, the PCE index, has also slipped to 1.4%, although this is expected to increase back to the central bank’s 2% target at some point next year.

Figure 3: US Inflation Rate (2013 - 2017)

3.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

Even amid the relatively disappointing inflation news, policymakers in the US surprised much of the market by keeping their expectations for future hikes broadly unchanged in June from their previous projections in March. The central bank’s “dot plot”, which represents where each member of the committee expects rates to be at the end of each year, showed that the Fed now expects one additional hike in 2017 and a further three next year, a much faster pace than the market is currently pricing in (Figure 4).

The indefinite delay of both the tax cut and the infrastructure package led us to revise our call from two hikes to just one in the second half of 2017. This will probably happen at the December meeting, while the Fed will use the September meeting to firm up plans to begin reducing its balance sheet. We also expect an additional three times next year provided the US economy continues to tick along nicely.

There is now a major gap between interest rate expectations for further Fed moves and those of Federal Reserve officials themselves. We expect rate markets to eventually throw in the towel and price a path for hikes consistent with the dot plot. While this should keep the Dollar well supported against its major peers, we are revising our EUR/USD forecasts higher to reflect recent Euro strength and the growing likelihood that we’ll see an announcement on a tapering in the ECB’s stimulus programme in September.

Figure 4: FOMC June Dot Plot

4.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

 

EUR/USD

GBP/USD

Q3 -2017

1.15

1.29

E-2017

1.12

1.29

Q1-2018

1.10

1.30

Q2-2018

1.10

1.30

E -2018

1.10

1.32

 

 

UK Pound (GBP)

Sterling has suffered from a particularly volatile couple of months since the surprise result of the snap General Election in June. The Pound depreciated by around 2% against the Dollar on election night after the Conservatives unexpectedly fell short of an overall majority. However, the currency has bounced back well, primarily off broad USD weakness, rallying to its strongest position in 14 months in August (Figure 5).

Figure 5: GBP/USD (August ‘16 - August ’17)

5.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

Once again the opinion polls were proven wrong in June. The bulk of the surveys had given Theresa May’s party a comfortable advantage going into the vote. The Conservative Party obtained just 317 seats, a drop of 13 on the 330 obtained in 2015, and 9 seats short of an overall majority. The Tories have since formed a minority government with the Democratic Union Party (DUP) after two weeks of negotiations. While this eliminates the near term uncertainty of a hung parliament, the election result is likely to weaken the Prime Minister’s hand in the crucial Brexit negotiations, which formally began in June. The negotiations themselves are likely to be long and drawn out and are looking increasingly likely to take longer than the two year window set out in Article 50.

On the macroeconomic front, the UK economy has continued to tick along relatively well, despite the uncertain political backdrop. The Bank of England’s MPC surprised the market in June with an additional two of the eight committee members, Ian McCafferty and Michael Saunders, voting for an immediate interest rate hike. The vote remained unchanged at 6-2 in August, although Mark Carney struck a more dovish tone, while the MPC cut its growth forecasts.

The chances of a sooner-than-expected hike have taken somewhat of a hit by the slowdown in inflation. Headline inflation rose to a four year high 2.9% in May (Figure 6), although has since moderated to just 2.6%. We have been saying for a while there is a limit as to how high inflation can go before the Bank of England begins discussing higher rates and the increase in dissenters at the latest meeting vindicates this view. However, we would probably need inflation to exceed the 3% level before additional policymakers vote for an immediate rate hike.

Figure 6: UK Inflation Rate (2013 - 2017)

6.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

Communications from a number of rate setters of late have been relatively hawkish. Chief Economist Andy Haldane has indicated he may soon vote for a hike, while Governor Mark Carney acknowledged at a speech at an ECB conference in Portugal that the central bank would debate the need for higher interest rates “in the coming months”. The drop off in inflation of late has, however, caused market pricing for a hike in 2017 to drop fairly sharply to around 25%, slightly too low in our view.

Overall activity in the UK economy has also been relatively encouraging. Growth picked up pace somewhat to 0.3% in the second quarter of the year. The business activity PMI’s have remained solid and comfortably above the level of 50 that denotes expansion. Britain’s manufacturing index rose to a near three year high 57.3 in April while the country’s dominant services sector has remainder around the 54 to 56 mark in the past few months (Figure 7), equivalent to an approximate 0.5% quarterly expansion in GDP. A significant stumbling block to higher growth in the UK this year is the now negative real earnings growth which currently stands at a three year low -0.5%. We note, however, that this is entirely due to the pickup in inflation rather than any softness in nominal wage growth.

Figure 7: UK Services & Manufacturing PMIs (2014 - 2016)

7.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

We remain fairly optimistic about the UK economy and still think that there is a very good chance the Bank of England could acknowledge as much by raising interest rates sooner than the market is currently pricing in. However, given the recent soft inflation print and dovish rhetoric from Governor Carney during the most recent MPC meeting we now think this is unlikely to take place until the first quarter of 2018 at the earliest.

Following the loss of the Tories’ majority at June’s election it is also clear that hopes of Britain achieving a more favourable deal with the EU have taken a blow. We see the prospect of a sooner-than-expected Bank of England rate hike as more or less balanced out by this uncertainty, and keep our Sterling forecasts unchanged. We expect only a relatively modest appreciation of the currency against the US Dollar.

 

GBP/USD

GBP/EUR

Q3-2017

1.28

1.12

E-2017

1.29

1.16

Q1-2018

1.30

1.18

Q2-2018

1.30

1.19

E-2018

1.32

1.20

 

 

Euro (EUR)

The Euro has continued on its relentless upward trend against the US Dollar since the beginning of the year, jumping to its strongest position in two-and-a-half years in August.

Sentiment towards the common currency has improved significantly in the past few months amid a general improvement in economic conditions within the Euro-area and growing expectations that the European Central Bank (ECB) will announce a winding down of its stimulus programme in the autumn (Figure 8).

Figure 8: EUR/USD (August ’16 - August ’17)

8.jpg

Source: Thomson Reuters Datastream, Date: 17/08/2017

The single currency spiked by over one percent following the European Central Bank’s July meeting which was somewhat surprising given Draghi maintained his fairly dovish rhetoric during his press conference. The central bank chief highlighted the need for the ECB to remain both “persistent” and “patient” with its large scale stimulus programme. Draghi reiterated that the risks to growth in the Eurozone remained “broadly balanced”, although underlying inflation was yet to show any convincing signs of a pick-up and that a “substantial degree of accommodation” was still needed.

The rather aggressive upward move in the common currency can instead be largely attributed to his claim that discussions on changes to the QE programme should take place in the autumn.

Investors are now increasingly confident that Draghi will announce a tapering, or dialling back, of the central bank’s QE programme as early as September following an impressive rebound in economic activity in the Eurozone.

Growth in the second quarter of 2017 rose to 0.6%, outpacing both the US and UK economies. The latest business activity PMIs out of the Eurozone have also been impressive, pointing towards another robust performance in the third quarter of the year. Both the services and manufacturing PMIs have increased to multi-year highs in recent months. The crucial composite PMI, an index representing a weighted average of the two sectors, has declined for the past two months, although came in at a still very impressive 55.8 in July following a slowdown in manufacturing activity (Figure 9).

Figure 9: Eurozone Composite PMI (2014 - 2017)

9.png


Source: Thomson Reuters Datastream, Date: 17/08/2017

Headline inflation rose to a four year high in February, although it has since trailed off to just 1.3% in July (Figure 10). The level of core inflation in the currency bloc, however, remains pinned well below the central bank’s “close to, but below” 2% target. Core inflation did increase to an above consensus 1.2% in July, although this has been driven predominantly by volatile components and there is a good chance that this modest bounce could prove temporary.

Figure 10: Eurozone Inflation Rate (2013 - 2017)

10.png

Source: Thomson Reuters Datastream, Date: 17/08/2017

Regardless, it is clear that economic conditions in the Eurozone are improving and Mario Draghi’s comments that a discussion on stimulus measures would happen in the autumn indicates that we could see the announcement of a tapering of the QE programme in September. We are therefore revising our forecasts for the Euro higher across the board. However, the process of policy normalisation in the Eurozone will almost certainly be a very gradual one, while we think the market is continuing to underestimate the chances of a rate increase by the FOMC in December. We therefore continue to expect a depreciation of the common currency against the US Dollar during the remainder of the year, followed by a stabilisation in 2018

 

EUR/USD

EUR/GBP

Q3-2017

1.15

0.89

E-2017

1.12

0.86

Q1-2018

1.10

0.85

Q2-2018

1.10

0.84

E-2018

1.10

0.83

 

 

Japanese Yen (JPY)

The Japanese Yen (JPY) has continued to suffer from a rather up and down few months and has remained stuck within the 110-115 range against the US Dollar throughout almost the entirety of the year so far (Figure 11). The currency slipped to its lowest level against the US Dollar in around four months in early July on renewed dovishness on the part of Japan’s central bank, although has since regained ground off the back of geopolitical risks and broad USD weakness.

Figure 11: USD/JPY (August ’16 - August ’17)

11.png

Source: Thomson Reuters Datastream Date: 18/08/2017

The Bank of Japan has kept its monetary policy unchanged as it continues in its quest to lift inflation back towards its 2% target level. At its July meeting, the BoJ’s monetary policy committee claimed that the economy was “expanding moderately”, having previously described it as “tuning toward a moderate expansion” in June. It also upgraded its growth forecasts and now expects the economy to expand by 1.8% in the current financial year compared to its previous 1.6% forecast.

However, BoJ Governor Haruhiko Kuroda struck a dovish tone by reiterating the central bank’s resolve to maintain its stimulus programme until inflation exceeded its target. He also calmed speculation that policymakers could back away from negative interest rates next year. Its so-called “quantitative and qualitative monetary easing with yield curve control” will see the bank purchasing government bonds at an annual pace of 80 trillion Yen in order to maintain a 10 year government yield of around zero. This large scale easing, combined with its negative -0.1% deposit rate, will continue until inflation exceeds the central bank’s 2% target level.

Despite its best efforts, the BoJ has continued to fail in its objective to lift headline inflation back to its target level. The main rate of consumer price growth has remained stuck at 0.4% for each of the three months through to June (Figure 12), having failed to breach the half a percent mark in every month since the removal of the sales tax hike from the index in 2015. The core measure, which excludes fresh food, also remained flat at 0.4% in June and the Bank of Japan was forced into pushing back its forecast for when it will reach its 2% target in July. Policymakers now expect price growth to increase towards 2% in 2019/20 rather than the 2018/19 previous estimate.

Figure 12: Japan Inflation Rate (2012 - 2017)

12.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Japan’s economy has continued to grow at a modest pace. GDP expanded by a slightly weaker-than-expected 0.3% in the first quarter given an unexpected decline in oil inventories and private consumption (Figure 13). Growth in the second quarter was far more encouraging with the economy expanding by an annualised 4%. An improvement in labour market conditions has helped fuel consumption so far this year with real household spending rising by 0.8% in June. A sharp drop in the unemployment rate to just 2.8% and the highest jobs-to-applicant ratio since data was first collected in 2004 should help support domestic demand throughout the remainder of the year. Exports are also rising again year-on-year in 2017, albeit at a slightly slower pace than imports.

Figure 13: Japan GDP Growth Rate (2012 - 2017)

13.png

Source: Thomson Reuters Datastream Date: 18/08/2017

As the world's most foremost safe-haven currency, the Yen has continued to prove susceptible to geopolitical risks. The news that North Korea launched a missile test in July sent JPY back towards the 110 mark and the potential for the escalation in tensions clearly presents risk of appreciation in the Yen. However, the Bank of Japan is looking set to continue to maintaining its aggressive monetary policy this year, contrary to some in the market have been anticipating a tightening. Given this still loose monetary policy stance we continue to forecast a gradual depreciation of the currency from current level against the US Dollar.

 

 

USD/JPY

EUR/JPY

GBP/JPY

Q3-2017

115

132

148

E-2017

118

132

153

Q1-2018

120

132

156

Q2-2018

120

132

157

E-2018

120

132

158

 

 

Swiss Franc (CHF)

The Swiss Franc (CHF) has sold-off sharply so far in the third quarter of the year, slumping to its lowest level since the removal of its Euro cap in January 2015 in July (Figure 14). Broad Euro strength, renewed dovishness on the part of the Swiss National Bank (SNB) and an unwinding of safe-haven flows has caused CHF to be the worst performing G10 currency so far in the second half of the year.

Figure 14: EUR/CHF (August ’16 - August ’17)

14.png

Source: Thomson Reuters Datastream Date: 18/08/2017

The wave of selling in the Franc in late-July also appears to have been amplified by the triggering of stop-loss buy orders above the psychological 1.11 level against the Euro. For its part, the SNB has also remained one of the more dovish G10 central banks, even amid a general improvement in global economic conditions. Policymakers in Switzerland voted to keep its record low deposit rate at -0.75% again in June. SNB President Thomas Jordan has also continued to claim the Franc is “significantly overvalued”, although these claims did come before the recent sharp depreciation. Jordan has made the bank’s preference for a weaker currency abundantly clear in order to improve the country’s export position.

The SNB has remained active in the FX market in the past few months, intervening through buying foreign currency in order to weaken the Franc. Currency intervention remains a viable policy tool for the central bank, although the recent weakness in the Franc should limit the need for it. The re-weighting of the SNB’s exchange rate index back in March reflecting a weaker CHF than originally expected may also lessen to need for currency intervention.

Inflation in Switzerland has disappointed in the past few months with headline consumer price growth slipping back to just 0.2% in June, its lowest level since December 2016 (Figure 15). Core inflation has, however, shown some encouraging signs and has spent the last four months in positive territory, having been below zero in every month for almost two years.

Figure 15: Switzerland Inflation Rate (2010 - 2017)

15.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Growth has also remained fairly weak in Switzerland with the economy expanding by just 0.3% quarter-on-quarter in the first three months of the year versus the 0.2% quarterly growth recorded in the final three months of last year (Figure 16). A modest acceleration during the remainder of the year looks on the cards following an impressive rebound in manufacturing activity. Switzerland’s manufacturing PMI posted its strongest reading in more than six years in July, rising to 60.9, well above the long term average of 53.8. Consumer confidence is also on a steady upward trend, while wage growth is now back around its highest level in two years, both of which should support consumer spending.

Figure 16: Switzerland Growth Rate (2010 - 2017)

16.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Chairman of the SNB Thomas Jordan has stood by the existing expansionary monetary policy stance following Switzerland’s relatively soft economic performance so far this year. However, the sharp depreciation in CHF and likelihood of an imminent tightening in monetary policy by the European Central Bank should limit the need for additional stimulus from the Swiss National Bank. Even in the event of a policy normalisation we think that the Swiss National Bank will remain committed to preventing an appreciation of the Franc. Recent weakness in the currency has certainly helped in this regard and should allow policymakers to stabilise the currency at a slightly higher level against the Euro than we had originally anticipated.

 

USD/CHF

EUR/CHF

GBP/CHF

Q3-2017

0.95

1.09

1.22

E-2017

0.97

1.09

1.27

Q1-2018

0.99

1.09

1.29

Q2-2018

0.99

1.09

1.30

E-2018

0.99

1.09

1.31

 

 

Australian Dollar (AUD)

The Australian Dollar (AUD) has got off to a very impressive start to the third quarter so far. The currency rallied to its strongest position against the US Dollar in fifteen months at the end of July (Figure 17) off the back of broad USD weakness and a renewed rebound in commodity prices, of which accounts for around 70% of overall Australian exports.

Figure 17: AUD/USD (August ’16 - August ’17)

17.png

Source: Thomson Reuters Datastream Date: 18/08/2017

At its August meeting the RBA issued a moderately more upbeat assessment of the domestic economy. However, the central bank inserted a new paragraph in its statement claiming that the appreciation in the currency would likely result in a slower pick up in both growth and inflation that it had originally anticipated. Weaker-than-expected growth has remained a stumbling block to higher interest rates in Australia this year.

The economy has expanded at a much slower pace than hoped in the past twelve months with GDP growing by just 1.7% year-on-year in the first quarter of the year, albeit extending its run to a record 26 years without recession. Mining activity once again contracted while consumer spending remained soft amid record low levels of wage growth. Real earnings growth in Australia is now negative for the first time since the second quarter of 2014 and only the fifth occasion since the financial crisis (Figure 18). Policymakers did, however, signal renewed confidence in the labour market following the largest two-month gain in jobs in almost 30 years and an unemployment rate that is around its lowest level since mid-2013.

Figure 18: Australia Real Earnings Growth (2002 - 2017)

18.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Consumer prices are expected to remain subdued this year with the RBA warning that the strong AUD would result in a slower pick-up in inflation than forecast. Headline inflation slipped back to a below target 1.9% in the second quarter of the year amid soft earnings growth, low fuel costs and a decline in fruit prices (Figure 19). The sharp appreciation in AUD since the beginning of July will certainly do nothing to help lift inflation back to the 2-3% target. The central bank is now forecasting inflation to remain around the 1.5-2.5% level during the remainder of this year and throughout 2018.

Figure 19: Australia Inflation Rate (2006 - 2016)

 19.png

Source: Thomson Reuters Datastream Date: 18/08/2017

The unexpected increase in concern about the strength of AUD marks a noticeable shift in tone from the slightly more hawkish tilt adopted by the RBA earlier in the year. Considering the recent appreciation in the currency, and still below target inflation, it appears that the prospect of an interest rate hike remains a long way off. Financial markets are currently discounting the possibility of a rate increase until a far out as the third quarter of 2018.

While AUD should remain well supported by the expected recovery in commodity prices this year we think that the prospect of stable policy in Australia for the foreseeable future limits upside potential for the currency. We therefore forecast a relatively stable Australian Dollar against the USD below current levels.

 

AUD/USD

EUR/AUD

GBP/AUD

Q3-2017

0.77

1.49

1.68

E-2017

0.75

1.49

1.73

Q1-2018

0.75

1.47

1.73

Q2-2018

0.75

1.47

1.75

E-2018

0.75

1.47

1.76

 

 

New Zealand Dollar (NZD)

The New Zealand Dollar (NZD) has recovered well in the past few months. Having depreciated to its lowest level in eleven months in May, NZD rose back to its strongest position against the US Dollar in over two years in July, with the broad USD sell-off extending the currency’s gains to 9% in just two-and-a-half months (Figure 20).

Figure 20: NZD/USD (August ’16 - August ’17)

20.png

Source: Thomson Reuters Datastream Date: 18/08/2017

At its August meeting, the Reserve Bank of New Zealand (RBNZ) left interest rates unchanged again at 1.75%, in line with consensus. The RBNZ stuck to its neutral monetary policy stance, claiming that there was no need to cut interest rates again given inflation was likely to pick-up. Governor Graeme Wheeler also appeared less worried about the recent strength of NZD that many onlookers had expected. He did, however, claim that monetary policy would remain accommodative for a “considerable period” and maintained its projection that the bank’s main rate will not rise until the third quarter of 2019.

The central bank lowered its projections for inflation in August. Consumer price growth has shown some encouraging signs in the past few months, having remained stuck below 1% for over two years through to the end of 2016. Headline inflation rose to a five year high 2.2% in the first quarter of the year, although it slipped back to 1.7% in the three months to June following a fall in fuel costs and airfares. Expectations for future inflation have also fallen for the third quarter to 1.8% over the coming year, underlying the need for the RBNZ to remain accommodative in its monetary policy stance.


Figure 21: New Zealand Inflation Rate (2010 - 2017)

21.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Economic growth has also slowed again so far in 2017, despite a noticeable pick-up in consumer spending. The New Zealand economy grew by a less-than-expected 2.5% year-on-year in the first quarter, its slowest pace of expansion since the final quarter of 2015. Unusually high spring rain lowered dairy production while sluggish building activity weighed on the construction sector. A general improvement in labour market conditions should, however, support growth during the remainder of the year. New Zealand’s labour market has been robust in the past eighteen months, with the jobless rate falling to an eight year low 4.8% in the second quarter off the back of record tourism and the recent recovery in dairy prices.

Figure 22: New Zealand Annual GDP Growth Rate (2010 - 2017)

22.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Recent communications out of the RBNZ confirm our expectation that the central bank will likely keep its main interest rate on hold for the foreseeable future. The central bank has claimed policy will remain accommodative for a “considerable period”, although we acknowledge there is a risk it may hike sooner-than-expected should inflation continue to surprise to the upside. Given the prospect of stable policy in New Zealand and rising interest rates in the US we continue to expect a modest depreciation of NZD against the US Dollar this year, followed by a stabilisation in 2018.

 

NZD/USD

EUR/NZD

GBP/NZD

Q3-2017

0.67

1.72

1.93

E-2017

0.66

1.70

1.97

Q1-2018

0.66

1.67

1.97

Q2-2018

0.66

1.67

1.98

E-2018

0.66

1.67

2.00 

 

 

Canadian Dollar (CAD)

The Canadian Dollar (CAD) rose to its strongest position in over two years in July with a surprise interest rate hike by the Bank of Canada and a recovery in oil prices contributing to the currency’s near 10% appreciation since early May (Figure 23).

Figure 23: USD/CAD (August ’16 - August ’17)

 23.png

Source: Thomson Reuters Datastream Date: 18/08/2017

In July the Bank of Canada (BoC) became the first G10 central bank, with the obvious exception of the Federal Reserve, to begin normalising monetary policy since the sharp decline in oil prices forced global inflation lower in 2014. The BoC raised rates by 25 basis points to 0.75%, its first hike in seven years. Policymakers judged the recent slowdown in inflation as temporary, while reiterating its commitment to remaining data-dependant. The bank’s overall assessment of the economy was also fairly upbeat and financial markets are now pricing in another rate increase at the October meeting with a realistic possibility of a hike as soon as September should economic news surprise to the upside.

The recovery in oil prices has also supported the Canadian economy and its currency. Oil rose back to a near two-and-a-half month high above $52 a barrel in August, contributing to CAD’s near 7% appreciation since the beginning of June. The Canadian Dollar follows a very similar path to that of oil prices (Figure 24), which is unsurprising given oil accounts for around a quarter of Canada’s overall export revenue.

Figure 24: CAD/USD vs. Crude Oil Prices (2014 - 2017)

24.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Last month’s surprise increase in the Bank of Canada’s main rate followed the impressive rebound in economic activity in Canada. Canada' economy expanded by 2.3% in the first quarter of the year, its fastest pace since the third quarter of 2014. Canada’s economy should be well supported this year from an impressive labour market performance. The Canadian economy added a net 55,000 jobs in May and another 10,900 in June, ensuring the 12 month gain in jobs is now at its largest since 2007. The jobless rate also fell to a nine year low 6.3% in July (Figure 25), which could encourage a sooner-than-expected hike.

Figure 25: Canada Unemployment Rate (2009 - 2017)

25.png

Source: Thomson Reuters Datastream Date: 18/08/2017

Inflation has fallen again and slipped back to just 1% in June, marking its slowest pace since 2015. However, Bank of Canada Governor Stephen Poloz has claimed that this was due to temporary factors and that prices would actually overshoot the central bank’s target by 2019. Given the BoC’s lack of concern for weak inflation and the hawkish rhetoric out of the July meeting there is now a very good chance policymakers could raise interest rates again this year in either October or December. The prospect of higher rates should provide good support for CAD and we are revising our forecasts lower, albeit still reflecting a modest depreciation in the currency from current levels versus the US Dollar.

 

 

USD/CAD

EUR/CAD

GBP/CAD

Q3-2017

1.30

1.50

1.68

E-2017

1.35

1.51

1.76

Q1-2018

1.35

1.49

1.76

Q2-2018

1.35

1.49

1.77

E-2018

1.35

1.49

1.78

 

 

Swedish Krona (SEK)

Expectations that Sweden’s central bank, the Riksbank, is coming to the end of its easing cycle has caused the Swedish Krona (SEK) to be one of the best performing G10 currencies in the past three months. The currency has been roughly unchanged against a broadly strong Euro so far in 2017 (Figure 26), while rallying to its strongest position against the US Dollar in over a year in August.

Figure 26: EUR/SEK (August ’16 - August ’17)

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Source: Thomson Reuters Datastream Date: 18/08/2017

The Riksbank has long been one of the more extremely dovish major central banks, defying expectations again in April and further extending its large scale quantitative easing programme to bring the total amount of purchases to a massive SEK 290 billion. However, at its July meeting, policymakers in Sweden acknowledged further interest rate cuts below the existing record low -0.5% were unlikely.

The central bank remains wary of weak inflation, particularly given the strong currency is likely to feed through to lower prices in Sweden’s small open economy. Inflation is Sweden is now finally showing signs of a sustained rebound. Consumer prices increased by 1.7% in the year to June, just shy of the five year high 1.9% reached in April (Figure 27). The level of core inflation has also been around the central bank’s 2% target for each of the past three months. This will be welcome news to policymakers that have been battling deflation for much of the past four years.

Figure 27: Sweden Inflation Rate (2013 - 2017)

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Source: Thomson Reuters Datastream Date: 18/08/2017

In another encouraging sign, growth in Sweden has blown expectations out of the water so far in 2017. The economy expanded by a whopping 4% on a year previous and 1.7% quarter-on-quarter in the three months to June, its fastest pace of growth since 2010 and well above even the most optimistic of forecasts. Retail sales rose to a seven month high 3.5% in June, defying the latest decline in real earnings growth which declined to a six year low in May, having fallen into negative territory in five of the past six months (Figure 28). Industrial production has jumped by a massive 8% year-on year, around its fastest pace of growth since 2011. The country’s balance of trade is also now back into positive territory, registering its highest surplus in eighteen months in June.

Figure 28: Sweden Average Earnings Growth (2011 - 2017)

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Source: Thomson Reuters Datastream Date: 18/08/2017

It is clear that economic fundamentals in Sweden are improving and the country is in a much healthier position than it was when the Riksbank extended its quantitative easing programme back in April. We think that the next move in rates is much more likely to be up than down, and there is a good chance the central bank could follow suit with the European Central Bank and begin signalling a normalisation in policy before the end of the year. Given the likelihood of a normalisation in policy in Sweden, we continue to forecast a gradual appreciation of the Krona against the Euro from current levels.

 

USD/SEK

EUR/SEK

GBP/SEK

Q3-2017

8.15

9.40

10.55

E-2017

8.30

9.30

10.80

Q1-2018

8.25

9.10

10.75

Q2-2018

8.20

9.00

10.70

E-2018

8.00

8.80

10.55

 

 

Norwegian Krone (NOK)

The Norwegian Krone (NOK) has made a good start to the third quarter of the year, having sold-off fairly sharply in the first half of the year against the Euro. The currency fell to its lowest level against the common currency in sixteen months in June, although has since regained ground off the back of another recovery in global oil prices (Figure 29).

Figure 29: EUR/NOK (August ’16 - August ’17)

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Source: Thomson Reuters Datastream Date: 18/08/2017

NOK is heavily correlated with the evolution of oil prices and the two follow a very similar trend given oil accounts for a very sizable two-thirds of the country’s overall export revenue. Oil slipped to a seven month low in June, although has since jumped back above $52 a barrel, coinciding with the recent recovery in the Krone (Figure 30).

Figure 30: NOK/USD vs. Crude Oil Prices (2011 - 2017)

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Source: Thomson Reuters Datastream Date: 18/08/2017

Norway’s economy has also picked up pace, in line with higher oil. The economy grew by 2.6% year-on-year in the first quarter following a broad based pick up that suggests the contraction in the oil service industry may have reached an end. Manufacturing production is finally back in positive territory again for the first time since 2015, while output in the industrial sector grew at its fastest pace in over a year in June. Business confidence in currently at a three year high, which would suggest a further acceleration in growth may be on the cards in the third quarter.

Norges Bank kept interest rates unchanged at its latest monetary policy meeting in June although, in a similar vein to the Riksbank, suggested that interest rates were unlikely to be lowered any further with hikes possibly to begin in 2019. This marks a removal in its recent easing bias that had previously said that interest rates were more likely to fall than increase in the short term. The central bank has held its main interest rate steady since early-2016 following a series of cuts that lowered the main rate 100 basis points to 0.5%. The prolonged period of stable policy has caused inflation to slow again. Headline inflation slipped to 1.5% in July, which is now comfortably below Norges Bank’s 2.5% target and around its lowest level since 2013.

Figure 31: Norway Inflation Rate (2013 - 2017)

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Source: Thomson Reuters Datastream Date: 18/08/2017

Despite recent soft inflation data it appears unlikely that Norges Bank will adjust its policy any time soon, providing the economy continues to grow at a steady clip. A shift in tone away from rate cuts by the central bank and the expected recovery in oil prices should, in our view, lead to an appreciation of NOK against the Euro this year from current levels.

 

 

USD/NOK

EUR/NOK

GBP/NOK

Q3-2017

7.75

8.90

10.00

E-2017

7.85

8.80

10.20

Q1-2018

7.90

8.70

10.30

Q2-2018

7.90

8.70

10.35

E-2018

7.90

8.70

10.45

 

 

Danish Krone (DKK)

The Danish National Bank (DNB) has continued to have no trouble in maintaining the Danish Krone’s peg of 7.46 DKK to the Euro in the past few months. The DNB intervenes in the currency markets using its foreign exchange reserves on a regular basis in order to limit fluctuations around this rate.

Foreign exchange reserves in Denmark have remained stable this year, suggesting there has been very limited speculative pressure on the currency. The DNB sold just 1.1 billion DKK in July, a negligible increase in overall foreign exchange reserves on June (Figure 29). Even following recent intervention, foreign exchange reserves still only equate to just 20% of Denmark’s overall GDP, with reserves now 40% lower than their peak following the removal of the Swiss Franc’s Euro cap in January 2015.

Figure 32: Denmark Foreign Exchange Reserves (2012 - 2017)

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Source: Thomson Reuters Datastream Date: 18/08/2017

In order to deter speculative bets on the currency, the Danish National Bank has maintained its interest rate deep in negative territory at -0.65%, having held its policy steady since January 2016. Recent communications from the central bank suggest that rates will remain negative for the foreseeable future, although there may be some room for rates to be raised in order to alleviate pressure on an already overheated housing market. Broad Euro strength in 2017 should provide additional room for the DNB to normalise policy in the coming months.

The Danish National Bank has continued to reiterate its desire to maintain its peg against the Euro, claiming that they have limitless scope to alleviate appreciating pressure and deter another speculative attack on the currency. We think the still negative interest rate spread with the Eurozone and comfortable level of FX reserves in Denmark should allow the DNB to maintain the existing EUR/DKK peg at the 7.46 level for the foreseeable future.

 

 

USD/DKK

EUR/DKK

GBP/DKK

Q3-2017

6.50

7.46

8.35

E-2017

6.65

7.46

8.65

Q1-2018

6.80

7.46

8.80

Q2-2018

6.80

7.46

8.90

E-2018

6.80

7.46

8.95

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