G10 FX Forecast Revision – Q1 2017

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US Dollar rally falters on Trump protectionist rhetoric 

 

G10 currencies have been dominated by political news in recent months. The two big political surprises of 2016, the Brexit vote in June and the Presidential Election victory of Donald Trump in November, are continuing to have broad repercussions for almost every major world currency.

The US Dollar has reversed much of its initial gains following the election. Donald Trump’s protectionist rhetoric and lack of clarity of future fiscal policy plans has dampened hopes that the Trump administration could foster both greater spending and higher economic growth in the US.

The Federal Reserve still looks on track to continue hiking interest rates throughout 2017 following its monetary policy meeting in January. The Fed’s assessment of the economy remained relatively upbeat, with Chair Janet Yellen claiming that consumer and business sentiment was improving and that the labour market was forecast to build on recent strength. We think the solid economic performance in the US keeps the Fed on course to hike interest rates on around 3 occasions this year, roughly in line with the December ‘dot plot’.

News regarding the Brexit process has dominated headlines throughout 2017 so far in the UK. The High Court ruling in January has paved the way for Theresa May to trigger the formal EU exit talks before the end of her March 2017 deadline, although the formal talks are likely to be long and drawn out and the true effect on the UK economy is unlikely to be known for some time.

Meanwhile in Europe, investors have begun to turn their attention to upcoming political events this year. Anti-EU National Front leader Marine Le Pen is closing the gap in the polls between her main rivals and looks on course to make it through to the run-off of the French Presidential election in May. Elections in Germany, the Netherlands and possibly Italy will all start coming into the spotlight in the next few weeks and months.

In the commodity markets, oil has continued its upward trend so far in 2017 after OPEC announced its first production cut in 8 years at the back end of last year. Oil rose to an eighteen month high above $57 a barrel in January (Figure 1), with forecasts this year suggesting a further normalisation in prices is on the cards in the coming months. This has provided good support for the heavily oil-reliant Norwegian Krone and Canadian Dollar, both of which have recovered well from multi-year lows reached in 2016.

Figure 1: Crude Oil Prices & Commodity Price Index (February ’16 – February ’17)

1.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Commodity prices in general have increased in the past few months, led by the upward surge in oil. The commodity price index, which measures a weighted average of a select group of commodity prices, has risen by around 20% since the beginning of 2016. This has proven particularly good news for the Australian Dollar and New Zealand Dollar, both of which follow a remarkably similar trend to that of commodity prices. 

We think the key themes among the major currencies in the coming quarter will remain mainly political. News on the Trump administration's fiscal policy plans and the ease of the UK’s formal exit process from the European Union are likely to remain the key driving themes in the currency markets in 2017.

 

US Dollar (USD)

News out of the United States has been dominated by Donald Trump’s Presidency since he was sworn into office in January. The Dollar soared in the immediate aftermath of his election victory and rallied to its strongest position in 14 years against its trade-weighted basket of currencies in early-January in anticipation of greater spending, lower taxes and higher interest rates in the US under a Donald Trump presidency.

However, the Dollar rally appears to have lost steam on the back of Trump’s hard line stance on trade and the lack of clarity on his future spending plans and tax policy. Trump’s bleak and confrontational inauguration speech on 20 January emphasised his protectionist policies and disappointed investors hoping for a repeat of his upbeat victory speech in November.

Moreover, in a relatively unusually move for a United States President, Trump has voiced his concern that the US Dollar is “too strong”. While his pick for Treasury Secretary quickly downplayed these comments, these comments have been enough to send the US Dollar index to its weakest position in two-and-a-half months against its major peers (Figure 2).

Figure 2: US Dollar Index (February ’16 - February ’17)

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Source: Thomson Reuters Datastream Date: 07/02/2017

Meanwhile, the Federal Reserve hiked its benchmark interest rate for only the second time since the financial crisis in December. The Fed funds rate was raised by 25 basis points to a range between 0.5% and 0.75%, having spent a full year unchanged following the previous rate hike in December 2015.

All ten voting members of the committee threw their support behind an immediate rate increase. Policymakers in the US also validated our expectations for a hawkish turn by ramping up the path of future interest rates in 2017 and beyond. The FOMC’s ‘dot plot’, which makes explicit where each member of the committee expects rates to be at the end of each year, shows that the committee now expects on average three rate hikes in 2017, compared to just two outlined in September. Overall 11 of the 17 members thought that the Fed would hike on three occasions next year, quite a bit more hawkish than the market had anticipated (Figure 3).

Figure 3: FOMC December ‘Dot Plot’

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Source: Federal Reserve Date: 15/12/2016

Comments from Federal Reserve Chair Janet Yellen have remained fairly hawkish so far in 2017, reiterating that the FOMC is close to achieving its dual mandate of on target inflation and full employment. Rhetoric from FOMC members since the election has remained generally hawkish, and we see a risk that the Fed could hike more aggressively than the market is currently pricing.

Economic news out of the US remains impressive. The jobs market has continued to perform fairly well, with the US economy creating a better-than-expected 227,000 jobs in January (Figure 4). Unemployment remained at a nine year low 4.7%, although on the negative side wage growth dropped from a revised 2.8% to 2.5%. At the margins this report suggests that inflationary pressures in the US are not building quite at the pace we expected.

Figure 4: US Nonfarm Payrolls (2010 - 2017)

4.png

Source: Thomson Reuters Datastream Date: 07/02/2017

As was widely expected the Fed held rates steady at its 1 February meeting. However, the general tone from Janet Yellen was fairly upbeat, and while there were no clear indications for when the next rate hike will take place, the Fed left the door open for a move in March. Providing the labour market continues to perform well, we see March as a decent possibility for the next rate increase in the US and expect to see the Fed raise interest rates around three times in total in 2017, in line with the latest dot plot.

The process of rising interest rates by the Federal Reserve in the US should provide good support for the US Dollar in 2017 and we expect a gradual strengthening of the US Dollar from current levels against almost every G10 currency.

 

EUR/USD

GBP/USD

Q1-2017

0.99

1.20

Q2-2017

0.97

1.20

Q3-2017

0.96

1.21

E-2017

0.95

1.22

E-2018

0.95

1.24

 

UK Pound (GBP)

Sterling has continued to suffer from a volatile ride since the mysterious ‘flash crash’ in October. The Pound has been particularly sensitive to all news regarding the Brexit process, and the currency fell to a fresh 31 year low at the beginning of January on expectations that the UK was heading for a “hard Brexit”, where access to the European common market is limited (Figure 5).

Figure 5: GBP/USD (January ‘16 – January ’17)

5.png

Source: Thomson Reuters Datastream Date: 07/02/2017

This speculation was confirmed by Prime Minister Theresa May’s highly anticipated Brexit speech in the third week of January. May acknowledged that the UK would not remain within the single market, although she claimed the UK will seek the “greatest possible” access. The Pound soared off the back of May’s tone, which was slightly more conciliatory than had been expected, and received further support from the confirmation that parliament will vote on the terms of the deal.

The Supreme Court ruling in January also ensures that parliamentary approval will be required on the timing of Article 50, which sets the two year clock ticking on Britain’s exit from the European Union. The news that the Scottish Parliament does not require a say removes a potential major stumbling block. The vote does, however, ensure it remains uncertain as to whether Theresa May will be able to follow through with her plans to trigger the formal Brexit process before the end of March.

Economic news in the UK in the past few weeks has been mixed, although the economy has actually performed fairly well since interest rates were cut to a record low in reaction to the surprise Brexit vote in August. We think the economy is performing nowhere near the dire levels that would convince the Bank of England to cut interest rates further in the coming months and overall economic performance in the UK since June has certainly surprised to the upside.

The effect of a weaker Sterling, which is currently trading over 15% lower than its pre-referendum peak, is beginning to filter its way through to domestic prices. Inflation in the UK jumped to 1.6% in December, its highest level since July 2014 and comfortably above the levels recorded in November (Figure 6).

Figure 6: UK Inflation Rate (2013 – 2016)

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Source: Thomson Reuters Datastream Date: 07/02/2017

Moreover, the labour market in the UK continues to perform impressively. Unemployment has remained at its lowest level in a decade at 4.8%, while average earnings growth excluding bonuses also accelerated to 2.7% in the three months to November. The latest business sentiment PMI’s have also all picked up pace (Figure 7). The services PMI dipped to 54.5 in December although remains around its highest level in 17 months, while the manufacturing PMI is just shy of a 30 month high 55.9. Both of these key measures are comfortably above the level of 50 that denotes contraction and bode well for the final estimate of fourth quarter growth.

Figure 7: UK Services & Manufacturing PMI’s (2014 - 2016)

7.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The Bank of England sprung no surprises in January by voting unanimously to keep its benchmark interest rate unchanged. Policymakers again appeared in no rush to alter policy, although kept its options open to respond in either direction to changes in the economic outlook. The Bank of England is likely to remain in wait and see mode, although we think the next move in rates is far more likely to be a hike than a cut.

We think that the Pound will continue to remain sensitive and volatile to news and details of Britain’s EU exit in the coming months. However, we maintain existing levels are unsustainable low, and not justified by economic fundamentals. Investors also continue to price in just about the worst possible outcome to Brexit negotiations and we subsequently expect Sterling to trade in the 1.20 to 1.25 range against the Dollar, while rallying sharply versus the Euro this year.

 

GBP/USD

GBP/EUR

Q1-2017

1.20

1.21

Q2-2017

1.20

1.24

Q3-2017

1.21

1.26

E-2017

1.22

1.28

E-2018

1.24

1.31

 

Euro (EUR)

The Euro has stabilised somewhat so far in 2017, having had a torrid end to 2016 that saw the single currency tumble to a 14 year low against the US Dollar (Figure 8).

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

8.png

Source: Thomson Reuters Datastream Date: 07/02/2017

This weakness in the Euro came after the European Central Bank (ECB) ramped up its efforts to boost both growth and inflation in the Eurozone in December. Nearly two years after the launch of quantitative easing back in January 2015, the ECB announced it would be extending its horizon beyond the previous March 2017 end date. The ECB will now continue its asset purchases until the end of December this year or beyond, if necessary.

The Governing Council will continue purchasing 80 billion Euros a month up until the end of March, then will be lowering the monthly purchases to 60 billion Euros for the remainder of 2017. This increase in the ECB’s QE programme will now see an extra 540 billion Euros pumped into the Eurozone economy.

At its January meeting, President of the ECB Mario Draghi provided no real surprises, keeping policy unchanged and maintaining a fairly dovish tone. Draghi appeared unimpressed by the recent improvement in inflation in the Eurozone, suggesting the ECB would look past the latest spike in prices which he attributed to the recent stabilisation in global oil prices. Further, Draghi introduced a critical new focus for the ECB. In addition to overall Eurozone inflation, the divergences in inflation levels between the different countries are being monitored by the central bank.

Headline inflation in the Eurozone has picked up sharply in the past few months. Consumer prices increased by 1.8% in January, comfortably above expectations and its highest level since earl-2013
(Figure 8).

Figure 9: Eurozone Inflation Rate (2009 - 2017)

9.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The business activities PMI’s have also picked up pace in the past few months. The composite PMI remained around a multi-year high 53.3 in January (Figure 10). Manufacturing activity also rose above expectations to its highest level in over five years.

Figure 10: Eurozone Composite PMI (2014 - 2017)

10.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Given the improvement in economic conditions in the Euro-area we see no immediate need for the ECB to increase its already sizable stimulus measures. However, it is clear the policy divergence between the Governing Council and Federal Reserve will remain deep into 2018.

In tandem with the very loose monetary policy adopted by the European Central Bank, we also think the Euro will remain under pressure from political developments in Europe in 2017. A number of high profile elections this year are likely to begin coming into the spotlight in the next few weeks, the result of which could prove crucial to the long term future of the Euro-area as a whole.

First up, we have the general election in the Netherlands on 15 March, although anti-EU Party for Freedom leader Geert Wilders is looking very unlikely to garner enough support to form a majority government. France will also go to the polls in the final round of its election in May with populist National Front leader Marine Le Pen now in with a realistic chance of becoming next President. Online prediction website PredictIt currently gives Le Pen around a one-in-three chance of victory.

We remain of the opinion that the growing divergence in monetary policy between the European Central Bank and the Federal Reserve, combined with the growing political uncertainty in Europe, should recommence the Euro’s gradual downtrend against almost every G10 currency this year.

 

EUR/USD

EUR/GBP

Q1-2017

0.99

0.83

Q2-2017

0.97

0.81

Q3-2017

0.96

0.79

E-2017

0.95

0.78

E-2018

0.95

0.77

 

Japanese Yen (JPY)

The Japanese Yen (JPY) has rebounded somewhat so far in 2017, having sold-off sharply at the end of last year in reaction to a reversal in safe-haven flows into the currency in the aftermath of Donald Trump’s Presidential election victory in November.

The Yen had fallen to its weakest position in 10 months against the Dollar in December, although has since recovered around one-third of its losses (Figure 11).

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

11.png

Source: Thomson Reuters Datastream Date: 30/01/2017

Recent weakness in the Yen will be welcome news to the Bank of Japan in its bid to lift both growth and inflation in Asia’s second largest economy. The central bank has continued to defy expectations by keeping its monetary policy unchanged. 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.

There have, at last, been some positive developments in inflation in the country in the past few months. The headline rate of price growth jumped to 0.5% in the year to November, only the third month of positive inflation in 2016 and its highest reading since May 2015 (Figure 12). However, consumer inflation expectations remain low and actually fell to its lowest level in four years in the three months to December. Core inflation also remains stuck below zero, with core prices declining by 0.3% in November.

Figure 12: Japan Inflation Rate (2013 - 2016)

12.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Growth in Japan also remains relatively weak with the GDP growing by just 1.3% annualised in the third quarter of 2016. The IMF now expects the economy to grow by 0.8% in 2017, a very modest upward revision from the 0.6% predicted back in November. On a more encouraging note, exports have finally risen for the first time in 15 months year-on-year in December. Exports rose by 5.4% (Figure 13), although Donald Trump’s potential protectionist policies have raised uncertainty over the future of Japan’s trade with the US, the country’s second largest trading partner.

Figure 13: Japan Exports vs. Imports (2012 - 2016)

13.png

Source: Thomson Reuters Datastream Date: 07/02/2017
The Yen has weakened in line with our forecasts so far in 2017. We think that the Bank of Japan will keep its monetary policy unchanged at a very aggressive level throughout 2017. Some in the markets are expecting a tightening of Bank of Japan policy at some point in 2017. We think these expectations will be disappointed, and therefore the Yen will remain under pressure against most major currencies into 2018.

 

USD/JPY

EUR/JPY

GBP/JPY

Q1-2017

113

112

136

Q2-2017

118

114

142

Q3-2017

119

114

144

E-2017

120

114

146

E-2018

120

114

149

 

Swiss Franc (CHF)

The Swiss National Bank (SNB) has continued to intervene to prevent an excessive appreciation of the Swiss Franc in the past few months. The Swiss currency has remained relatively range bound between the 1.06-1.09 levels (Figure 14), in line with our long standing forecasts for the Franc.

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

14.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The SNB has continued to reiterate its willingness to intervene in the foreign exchange market in order to stabilise the Franc which it deems “significantly overvalued”. The central bank intervened in the currency market following a sharp appreciation in the Franc in the immediate aftermath of the Brexit vote, and has continued to intervene sporadically ever since

Speaking in January, Chairman of the SNB Thomas Jordan re-emphasised the likelihood that interest rates will also remain deep in negative territory, claiming that the Swiss economy would suffer if interest rates were to be raised. At its December meeting, the central bank held its benchmark rate at -0.75% and we think that rates will be held at their current level throughout the remainder of this year.

Switzerland’s economic performance has continued to warrant the need for an accommodative monetary policy stance. Inflation was flat in December and has remained at or below zero in every month since mid-2014 (Figure 15), due largely to the effect of a stronger currency. Policymakers are now forecasting inflation of just 0.1% in Switzerland in 2017.

Figure 15: Switzerland Inflation Rate (2013 - 2016)

15.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The Swiss economy also failed to grow at all in the third quarter of 2016 quarter-on-quarter, and grew by just 1.3% on a year previous (Figure 16). Sluggish domestic consumption growth and soft exports as a result of the strong Franc mean that the SNB’s accommodative monetary policy stance is unlikely to be abandoned any time soon.

Figure 16: Switzerland Growth Rate (2010 - 2016)

16.png

Source: Thomson Reuters Datastream Date: 07/02/2017

It is clear that the Swiss National Bank remains fully committed to preventing appreciation of the Franc and its recent communications reiterate its lack of tolerance for a strong currency. Negative interest rates and the willingness of the central bank to continue intervening in the currency market one the one hand, and strong supportive flows from Switzerland massive current account surplus, on the other, lead us to expect a stable CHF against the Euro throughout the remainder of the year.

 

USD/CHF

EUR/CHF

GBP/CHF

Q1-2017

1.09

1.08

1.31

Q2-2017

1.11

1.08

1.34

Q3-2017

1.13

1.08

1.36

E-2017

1.14

1.08

1.39

E-2018

1.14

1.08

1.41

 

Australian Dollar (AUD)

The Australian Dollar (AUD) has recovered ground so far in 2017, having slumped to its weakest position against the US Dollar in seven months in December on the back of broad Dollar strength (Figure 17). A rebound in commodity prices has provided decent support for AUD, given commodity production accounts for around 70% of overall Australian exports.

Figure 17: AUD/USD vs. Commodity Prices (2011 - 2017)

17.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The Reserve Bank of Australia (RBA) has kept its interest rate unchanged at its record low 1.5% since rates were cut in August last year. Despite the record low rates and a stabilisation in oil prices, Australia’s economy has underwhelmed. GDP contracted by 0.5% in the third quarter of 2016, its weakest print since the financial crisis, with growth slowing to just 1.8% on a year previous. Government spending was weak amid a drawn out election process. Consumer spending has also proven soft, expanding at its slowest pace since late-2013. This has been partly due to sluggish wage growth which slumped to just 1.9% in the third quarter of last year (Figure 18).

Figure 18: Australia Average Wage Growth (2007 - 2016)

18.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Encouragingly, the recent stabilisation in commodity prices has begun to filter its way through to the Australian economy. Exports jumped by 16% YoY in November, due largely to the recent sharp increase in the prices for iron and coal, sending the country’s trade balance into surplus for the first time in almost three years.   

Inflation has also improved somewhat, although continues to remain below the central bank’s 2-3% target and has done so for each of the past nine quarters. Headline consumer price growth increased from a near 25 year low earlier in the year to 1.5% in the final quarter of 2016 (Figure 19). Inflation on the whole throughout 2016 was, however, the lowest in 19 years.

Figure 19: Australia Inflation Rate (2006 - 2016)

19.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Despite the relatively disappointing economic performance in Australia of late, the RBA has maintained a fairly neutral stance in its communications since it cut rates to a record low last year.  In fact, the January statement was fairly upbeat, acknowledging the steady improvement in the world economy, and blaming the third-quarter slowdown on temporary factors.

We think this statement supports our view that the RBA has brought its easing cycle to an end and the next move in rates will be up. We therefore expect a roughly stable Australian Dollar against the US Dollar this year, and a gradual appreciation of the currency versus the Euro.

 

AUD/USD

EUR/AUD

GBP/AUD

Q1-2017

0.74

1.34

1.62

Q2-2017

0.73

1.33

1.64

Q3-2017

0.73

1.32

1.66

E-2017

0.73

1.30

1.67

E-2018

0.73

1.30

1.70

 

New Zealand Dollar (NZD)

The New Zealand Dollar (NZD) has recovered well from its relatively sharp sell-off against the US Dollar in the immediate aftermath of the Presidential election, helped in part by a further stabilisation in commodity prices (Figure 20).

Figure 20: NZD/USD vs. Commodity Prices (2013 - 2017)

20.png

Source: Thomson Reuters Datastream Date: 07/02/2017

In reaction to the uncertainty created following the US Presidential Election, the Reserve Bank of New Zealand (RBNZ) slashed its benchmark interest rate in November to a fresh record low 1.75% from 2.0%. This marked the fifth rate cut in the past eighteen months. Governor of the RBNZ Graeme Wheeler alluded to the possibility of further cuts in the future amid elevated market volatility and heightened political uncertainty.

However, the central bank appears comfortable with the performance of the domestic economy, indicating it would not need to cut rates further, absent downside risks from abroad. New Zealand’s economy grew by a better-than-expected 3.5% in the third quarter of 2016 (Figure 21), supported by a solid performance in both the construction and manufacturing sectors.

Figure 21: New Zealand Annual GDP Growth Rate (2010 - 2016)

21.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Growth is expected to remain robust this year, bolstered by the record low interest rate and a stabilisation in dairy prices, New Zealand’s largest export earner. An improving labour market in the country should continue to support domestic consumption. Unemployment has fallen below 5% for the first time since the financial crisis, declining to an eight year low 4.9% in the third quarter of last year.

Inflation in New Zealand also surprised to the upside in the fourth quarter of last year. Consumer prices grew by 1.3% from a year previous (Figure 22), sharply higher than the 0.4% recorded in the second quarter and its strongest reading in three-and-a-half years. Inflation is now likely to return back to the 2% target slightly sooner than the late-2018 previously expected.

Figure 22: New Zealand Inflation Rate (2010 - 2016)

22.png

Source: Thomson Reuters Datastream Date: 07/02/2017

We think the RBNZ will be comfortable with a weak currency in a bid to prevent another sharp decline in inflation back to last year’s anaemic levels. We expect the Reserve Bank of New Zealand to maintain its accommodative monetary policy stance this year, with inflation still comfortably below the central bank’s target.

At its January  meeting, the central bank left crates unchanged and made it clear it is in no hurry to raise them until inflation rebounds, and it once again expressed its unhappiness with the currency’s strength. The divergence in monetary policy stance between the RBNZ and Federal Reserve, together with the explicit discomfort of the former with currency’s strength,  should ensure a continuation of the downward trend in the  New Zealand Dollar against the US Dollar this year.

 

NZD/USD

EUR/NZD

GBP/NZD

Q1-2017

0.68

1.46

1.76

Q2-2017

0.67

1.45

1.79

Q3-2017

0.66

1.45

1.83

E-2017

0.65

1.46

1.88

E-2018

0.65

1.46

1.91

 

Canadian Dollar (CAD)

The Canadian Dollar (CAD) traded within a relatively narrow range against the US Dollar in the second half of 2016 following a sharp sell-off at the beginning of last year that sent the currency to a 13 year low (Figure 23).

Figure 23: USD/CAD (2012 - 2017)

23.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The recovery in the currency has been fuelled by a rebound in oil prices in the past year, which accounts for around a quarter of Canada’s overall export revenue. The correlation between global oil prices and the evolution of the Canadian Dollar is very strong and it is no surprise that the currency has followed a remarkably similar trend to that of oil. Global oil prices have risen back above $55 a barrel this year and have more than doubled since falling sharply to its lowest level in 12 years at the beginning of 2016 (Figure 24).

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

24.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The economic performance in Canada has remained slightly disappointing in the past few months. The economy grew by 1.3% in the third quarter of 2016, although looks set to pick up pace off the back of an impressive labour market performance. Canada’s economy added 229,000 jobs last year, the most since 2012. The country’s balance of trade has also improved dramatically in the past few months, with a surge in exports sending the trade balance into surplus for the first time in two-and-a-half years (Figure 25). The Bank of Canada is forecasting growth of 2.1% in 2017.

Figure 25: Canada Trade Balance (2011 - 2016)

25.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Inflation also remained below the central bank’s 2% target throughout 2016. Headline consumer price growth rose slightly in December amid a stabilisation in oil prices, although remains at just 1.5%. Core inflation still remains stuck just above its lowest level since early-2014 at 1.6%.

The Bank of Canada (BoC) has continued to keep its benchmark interest rate unchanged at 0.5%, and has done so since rates were cut in mid-2015. At its January meeting, the BoC sounded a distinctly dovish note. It stated that the Canadian economy was operating “with material excess capacity”. Crucially, it explicitly mentioned the strength of the Canadian Dollar as a significant negative factor weighing on the outlook.

The Bank of Canada appears to have limited tolerance for currency strength. Further, the protectionist rhetoric of the Trump administration constitutes a hard-to-measure but meaningful downside risk to the outlook for the Canadian economy. We therefore maintain our expectation for a gradual Canadian Dollar depreciation against the US Dollar.

 

USD/CAD

EUR/CAD

GBP/CAD

Q1-2017

1.34

1.33

1.61

Q2-2017

1.35

1.31

1.62

Q3-2017

1.40

1.34

1.69

E-2017

1.45

1.38

1.77

E-2018

1.45

1.38

1.80

 

Swedish Krona (SEK)

The Swedish Krona (SEK) has recovered well so far in 2017. The currency sold-off sharply to a six-and-a-half year low against the Euro and seven year low against the US Dollar in October off the back of Sweden’s central bank, the Riksbank, maintaining its ultra-loose monetary stimulus measures.

Figure 26: EUR/SEK (January ’16 – January ’17)

26.png

Source: Thomson Reuters Datastream Date: 07/02/2017

The Riksbank has continued its efforts to boost inflation in Sweden and in fact stepped up its dovish rhetoric at the February meeting. Policymakers left the bond buying program unchanged after December’s expansion and kept their record low -0.5% interest rate in place, with a bias towards cutting further rather than hiking. More surprisingly, policymakers sounded a surprisingly aggressive note on the currency. They suggested that there is little tolerance for further appreciation in the short term, and extended the mandate that allows the central bank to intervene quickly in the market if needed.

These large scale stimulus measures at last appear to be bearing fruit, helped in part by a stabilisation in oil prices and a broad increase in global inflation. The headline rate of price growth jumped to a near five year high 1.7% in December (Figure 27), driven higher largely by a surge in transport prices.

Figure 27: Sweden Inflation Rate (2012 - 2016)

27.png

Source: Thomson Reuters Datastream Date: 07/02/2017

Despite the Riksbank’s accommodative monetary policy stance, growth in Sweden began to slow in the second half of 2016. Sweden’s economy grew by just 0.5% in the third quarter and by 2.8% on a year previous, its weakest rate of annual growth in two years. Economic growth is forecast to have slowed to 3.3% in 2016, although this remains enviable compared to many of the country’s European counterparts.

An improvement in labour market conditions in the country should help support consumer spending in the coming quarters. Unemployment in Sweden has been on a steady downward trend since the beginning of 2015, with the twelve month moving average falling to its lowest level since April 2009 in December (Figure 28).

Figure 28: Sweden Unemployment Rate (2010 - 2016)

28.png

Source: Thomson Reuters Datastream Date: 07/02/2017

While the slowdown in growth ensures that the Riksbank remains overwhelmingly in easing mode, the recent rebound in consumer prices should alleviate pressure on policymakers to ease monetary policy further in the coming months.

The appreciation of the Krona so far this year has been broadly in line with our expectations. However, we expect the warning issued by the Riksbank in February about intervention to cap further gains in SEK in the short term. Over the latter half of the year we expect that global reflation will calm Riksbank concerns and we will see a shift in their rhetoric, which will lead to a resumption of the Krona rally.

 

USD/SEK

EUR/SEK

GBP/SEK

Q1-2017

9.70

9.60

11.65

Q2-2017

9.60

9.30

11.50

Q3-2017

9.60

9.20

11.60

E-2017

9.45

9.00

11.55

E-2018

9.25

8.80

11.50

 

Norwegian Krone (NOK)

The Norwegian Krone (NOK) has recovered well in line with the increase in oil prices and broad US Dollar weakness so far in 2017, having fallen to a 14 year low against the US Dollar in early-2016. The Krone has now appreciated by close to 5% against the greenback since the beginning of January, while rallying to its strongest position against the Euro in seventeen months (Figure 29).

Figure 29: EUR/NOK (February ’16 – February ’17)

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Source: Thomson Reuters Datastream Date: 07/02/2017

The rebound in the Krone has been fuelled largely by the recent increase in oil prices (Figure 30), which accounts for around two-thirds of Norway’s overall export revenue. The Krone should continue to be well supported this year, particularly against the Euro, given oil prices are broadly forecast to continue rising in 2017.

Figure 30: NOK/USD vs. Crude Oil Prices (2011 - 2016)

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Source: Thomson Reuters Datastream Date: 07/02/2017

Norway’s central bank, Norges Bank kept its monetary policy unchanged at its December meeting, keeping its benchmark interest rate at 0.5%, the highest of any major central bank in Europe. Policymakers kept a fairly neutral stance, reiterating the main policy rate was likely to remain at its current level in the period ahead. The central bank caught investors completely wrong-footed in September last year by abandoning its base-case scenario for an additional rate cut it had held since December 2015. Norway has managed to avoid negative rates and unconventional monetary policy tools such as those deployed in Switzerland, Sweden and the Eurozone, chiefly in part to government spending and its oil wealth.

The move to a more neutral monetary policy stance from Norges Bank comes despite a fairly disappointing performance from the domestic economy in Norway in recent months. The economy contracted in the third quarter of last year by 0.9% on a year previous, its worst quarterly performance since early-2013, primarily due to a sharp contraction in oil production.

There have, however, been some encouraging signs of improvement in recent months. The country’s manufacturing PMI is back above the level of 50 that denotes expansion (Figure 31), mining production has been positive for each of the past six months, while consumer confidence is gradually improving having fallen to its lowest level in over 20 years at the beginning of 2016. Norway’s balance of trade has also improved due to an increase in exports. The trade balance registered its largest surplus since mid-2015 in December.

Figure 31: Norway Manufacturing PMI (2013 - 2016)

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Source: Thomson Reuters Datastream Date: 07/02/2017

Norges Bank’s shift away from additional rate cuts and the expected rebound in oil prices this year should provide decent support for the Krone in 2017. We therefore forecast a gradual appreciation for the currency against the Euro, with modest losses against the Dollar.

 

USD/NOK

EUR/NOK

GBP/NOK

Q1-2017

9.00

8.90

10.79

Q2-2017

9.12

8.85

10.95

Q3-2017

9.17

8.80

11.10

E-2017

9.16

8.70

11.15

E-2018

9.16

8.70

11.35

 

Danish Krone (DKK)

The Danish National Bank (DNB) has continued to defend the Danish Krone’s peg of 7.46 DKK to the Euro with relative ease in the past few months. Speculation that the peg could be scrapped has now all but completely evaporated.

Foreign exchange reserves in Denmark remained stable at the back end of 2016, with the DNB not intervening in the currency markets at all in the second half of last year in order to prevent an appreciation of the Krone. Reserves grew slightly to 457.8 billion DKK in January (Figure 32). This equates to just 20% of Denmark’s 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 - 2016)

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Source: Thomson Reuters Datastream Date: 07/02/2017

Falling reserves and the lack of any significant FX intervention in order to weaken the Krone suggests that the DNB has had little trouble in maintaining its fixed exchange rate against the Euro. The DNB has maintained its interest rate deep in negative territory at -0.65%, having raised rates in January 2016. While rates are likely to remain below zero for the foreseeable future the central bank could have room to raise rates again in the coming months in order to alleviate pressure on an already overheated housing market.

The Danish National Bank has continued to emphasise its desire to maintain its peg against the Euro for the foreseeable future, reiterating 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

Q1-2017

7.54

7.46

9.05

Q2-2017

7.70

7.46

9.25

Q3-2017

7.75

7.46

9.40

E-2017

7.85

7.46

9.60

E-2018

7.85

7.46

9.75

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