G10 FX Forecast Revision – Q4 2016

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Sterling falls to record low, Fed on course for 2016 hike

 

Foreign exchange market action has been dominated by the sharp depreciation in Sterling in the past few weeks, as the currency tumbled to historical lows following June’s Brexit vote.

The announcement from Prime Minister Theresa May that Article 50 will be triggered before the end of March 2017, which would set the two year clock ticking on Britain’s exit from the European Union, has severely worsened sentiment towards the Pound. The prospect of a ‘hard Brexit’, where the UK trades complete control of immigration policy for much reduced access to the single market, drove the currency to its lowest position against the Dollar in 31 years and sent the trade-weighted Sterling index to its lowest level on record in October.

Away from the Pound, investors are focused on the timing of the next interest rate hike by the Federal Reserve in the US, which now looks very likely to take place before the end of the year. The most recent labour report out of the US came in broadly in line with expectations with 156,000 jobs created in September. We think this reinforces our view that rates will be raised in the US for the second time in a year at the December FOMC meeting, although we do not rule out the possibility of a hike as soon as November.

By contrast, the European Central Bank (ECB) and Bank of Japan (BoJ) look set to expand their economic stimulus measures in the coming months. We think the ECB remains on course to extend the timeframe of its asset purchases beyond the current March 2017 end date at its December meeting, while the BoJ could be set for another rate cut as soon as November. The central banks in Australia and New Zealand both cut interest rates already in the third quarter.

Commodity prices have also begun picking up again, led by a stabilisation in the prices of oil since September. Oil prices rose back above $50 a barrel in early October and have now increased by 25% since the summer after OPEC announced an agreement to cut oil production for the first time in eight years (Figure 1). This has provided a significant boost for the oil-driven Norwegian Krone and Canadian Dollar.

Figure 1: Crude Oil Prices & Commodity Price Index (October ’15 – October ’16)

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Source: Thomson Reuters Datastream Date: 28/10/2016

Emerging market currencies in general have continued to rebound off early 2016 lows, buoyed by a stabilisation in commodity prices, exceptionally low interest rates in G10 countries, and a general disposition towards risk seeking on the part of international investors.

Meanwhile, the US Election on 8 November looks increasingly likely to yield a Democrat victory, with Hillary Clinton surging ahead in the polls following the two recent TV debates. We think the G10 currencies will largely overlook the election and pay far more attention to both political developments in Europe and the prospect of gradually increasing interest rates across the Atlantic.

 

UK Pound (GBP)

Sterling has fallen sharply since mid-September, driven lower by growing concerns that Britain’s pending exit from the European Union will mean loss of access to the Single Market. These fears have been reinforced by the hard line taken recently by Prime Minister May in speeches that seemed to prioritise restrictions on immigration over securing access to EU markets for British goods and services.

The Pound has crashed below its post-Brexit lows and was sent plunging to its weakest position against the US Dollar since 1985 in early-October, while slipping to a five year trough against the Euro (Figure 2).

Figure 2: Sterling Trade-Weighted Index (2011 – 2016)

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Source: Thomson Reuters Datastream Date: 28/10/2016

The current extreme levels of volatility in the currency were exacerbated by a mystery ‘flash crash’ overnight on 7 October, which saw Sterling nosedive by over 6% in a matter of minutes before recovering most of its losses (Figure 3). This was not triggered by additional news, rather by automated trading programs operating in an environment of low liquidity.

Figure 3: GBP/USD & GBP/EUR (06/10/2016 – 07/10/2016)

3.png

Source: Thomson Reuters Datastream Date: 07/10/2016

The heavy selling pressure in the currency followed comments from Prime Minister Theresa May that made it clear that restrictions on immigration were coming. This increases the likelihood of a ‘hard Brexit’ in which the UK’s access to the European common market is significantly restricted. May has stated that the triggering of Article 50, which would set the two year clock ticking on Britain’s EU exit, will now take place no later than the end of March 2017.

Sterling has largely ignored economic news out of the UK economy in the past few weeks, which has been less dire than many analysts had originally predicted. Fears of an outright recession in Britain this year have now almost completely abated following the release of the September business activity PMI’s, all of which exceeded expectations.

The services PMI, of which accounts for around 80% of overall economic output, dipped slightly from 52.9 to 52.6 (Figure 4), although remained well above the recessionary level print from July. Meanwhile, the manufacturing index soared to a 2 year high 55.4, buoyed by the effect of a weaker Sterling, while construction rose back above the level of 50 that denotes expansion for the first time in 4 months.

Figure 4: UK Purchasing Managers’ Indexes (2014 – 2016)

4.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Consumers in the UK also appeared to have shrugged off uncertainty created in the immediate aftermath of the Brexit vote. Retail sales growth surged by 5.9% on a year previous in July, marking its largest yearly expansion since September last year (Figure 5). Unemployment has remained unchanged at 4.9%, with average wage growth continuing to far exceed inflation in excess of 2%.

Figure 5: UK Retail Sales (2011 – 2016)

5.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The upshot is that the immediate positive impact of the Sterling devaluation on manufacturing and tourism may be outweighing the shock to confidence and investment plans.

Rhetoric from policymakers in the UK has been fairly mixed since the Bank of England cut interest rates to a record low 0.25% and ramped up its QE programme to £435 billion in August. Kristin Forbes has claimed she saw no need for a further interest rate cut, although Governor Carney has suggested a further easing of monetary policy could be on the cards should the economy slowdown as expected. We remain of the opinion that further easing measures could be on the way should economic data take another turn for the worse, although this now looks unlikely to occur before the end of the year.

Given the recent sharp depreciation in Sterling, we are revising our short term forecasts for the Pound lower. We think the UK currency will remain volatile in the coming few months. However, we maintain that current levels are unsustainably low and panicky predictions of “parity” between Sterling and the Euro are very unlikely:

  • Current levels leave the Pound extremely undervalued by any measure and price in just about the worst possible outcome for Brexit negotiations. Business, financial and academic leaders are putting pressure on the Conservative party, and there are signs that some of the more extreme measures mooted are already being walked back.
  • Rising inflation expectations mean we are unlikely to see any further rate cuts from the Bank of England, while we expect the ECB to announce an expansion of QE at its December meeting
  • Current levels in Sterling are well below what could be justified by interest rate differentials with other economies or even the most pessimistic short term forecast for the UK economy.

We therefore forecast a short term depreciation of the Pound against the US Dollar, although maintain our expectation for a long term stabilisation of the currency. This would, in our view, therefore lead to a gradual appreciation versus the Euro, though we acknowledge that this view is very dependent on an improvement in the political environment for Brexit negotiations from their current state.

 

GBP/USD

GBP/EUR

E-2016

1.25

1.20

Q1-2017

1.27

1.28

Q2-2017

1.28

1.32

Q3-2017

1.30

1.35

E-2017

1.30

1.37

E-2018

1.30

1.37

 

US Dollar (USD)

The Federal Reserve in the US has continued to edge closer to its first interest rate hike since December 2015.

Chair Janet Yellen made it clear that higher interest rates are on the horizon at the Fed’s September monetary policy meeting, acknowledging the US economy continues to improve and that the case for a rate increase had “strengthened”. The number of dissenters voting for an immediate rate increase in September rose from one to three, leaving the overall vote split at 7-3 in favour of no change in policy. We think that we are close to the tipping point where a majority of the committee will vote for a hike.

The all-important labour report out of the US in October was also consistent with an economy that no longer requires an emergency setting of monetary policy. The US economy created a slightly less-than-expected 156,000 jobs in September (Figure 6), although this was compensated by upward revisions to prior months including a 16,000 increase to the August estimate. The twelve month moving average has now remained above 200,000 for the past two-and-a-half years.

Figure 6: US Nonfarm Payrolls (2010 – 2016)

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Source: Thomson Reuters Datastream Date: 28/10/2016

Unemployment ticked up to 5.0% from 4.9% but this was on the back of a large increase in the labour force, as the healthy job market attracts more previously discouraged job seekers. Critically, wages continue to increase at a very healthy rate of 2.6% year-on-year, or 1.5% in real terms (Figure 7).

Figure 7: US Average Hourly Earnings (2011 – 2016)

7.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The US housing market also appears to be recovering at a steady pace, albeit still remaining well below pre-recession levels. Housing starts are hovering around an eight year peak, while new home sales rose sharply by over 12% in July to highest level since 2007.

While the currency markets have begun turning their attention to the US Presidential Election in November, we’ve so far seen little reaction in EUR/USD to either the opinion polls or TV debates. This possibly suggests that investors are unsure of the impact of a Donald Trump election victory, or have completely discounted the possibility. The latest opinion polls have shown a growing lead for Hillary Clinton, with the latest odds from prediction website fivethityeight.com showing an 80% probability of a Democrat victory.

While the chances of a November rate hike look relatively slim given the timing of the election, we think that the still impressive labour market performance in the US should allow the Federal Reserve to hike interest rates by a further 25 basis points at its December FOMC meeting. Financial markets are currently pricing in around a 75% chance of a hike before the year is out. Provided the labour market continues to hold up well in the face of higher rates, we expect to see additional hikes throughout 2017 roughly in line with the Fed’s September dot plot (Figure 8).

Figure 8: Federal Reserve September ‘Dot Plot’

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Source: Federal Reserve Date: 21/09/2016

Gradually increasing interest rates by the Federal Reserve should, in our view, recommence the US Dollar’s rally against almost every major currency, particularly so against both the Euro and the Japanese Yen. However, we are revising our year-end EUR/USD forecast moderately higher given the recent resilience shown by the single currency.

 

 

EUR/USD

GBP/USD

E-2016

1.04

1.25

Q1-2017

0.99

1.27

Q2-2017

0.97

1.28

Q3-2017

0.96

1.30

E-2017

0.95

1.30

E-2018

0.95

1.30

 

Euro (EUR)

The Euro has broken out of its recent range in the past few weeks, falling to a 7 month low against the US Dollar. In the two months to October the Euro traded within one of the tightest bands we’ve seen in recent times against the Dollar, remaining within the 1.11-13 range (Figure 9). The single currency has come under renewed pressure from both the European Central Bank’s (ECB) ultra-loose monetary policy stance and the raft of political problems currently plaguing much of Europe.

Figure 9: EUR/USD (October ‘15 - October ‘16)

9.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The ECB has maintained its large scale quantitative easing programme at 80 billion Euros a month since March while keeping both its main refinancing and deposit rates unchanged at 0% and -0.4% respectively at its October meeting. The Governing Council has surprised the market in the past two meeting by opting to not extend the timeframe of its asset purchasing programme beyond the existing March 2017 timeframe. The minutes of the meeting released in October did, however, express concern that inflation “was still not showing convincing signs of a sustained pickup”.

President of the ECB Mario Draghi has so far not provided any clear hints that further stimulus could be in the pipeline, with an extension of the programme not even discussed at the last meeting. Draghi reiterated his view that the central bank’s existing policy stance was working effectively, instead blaming Brexit uncertainty for the recent sluggish growth in the Eurozone.

Despite this, we think that the stream of poor economic news out of the Eurozone of late, particularly the stubbornly low level of inflation, means that at the very least an extension in the timeframe of purchases beyond March 2017 is now looking increasingly likely. We expect the QE programme to be extended by at least six months at the ECB’s December meeting.

Economic growth in the Eurozone remains very soft, with GDP growing by a lackluster 0.3% in the second quarter of the year following a 0.5% expansion in the first three months of 2016. The latest business activity PMI’s have also all declined so far in 2016, with the composite index falling to its lowest level in a year-and-a-half in August (Figure 10). The ECB has subsequently issued a minor downgrade to its growth forecasts for 2017 to 1.6% from 1.7%.

Figure 10: Eurozone PMI’s (2014 - 2016)

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Source: Thomson Reuters Datastream Date: 28/10/2016

Inflation in the Eurozone has also failed to show the meaningful turnaround that the ECB would have hoped for, having now shown little or negative growth in every month for almost two years. The ECB nudged their 2016 inflation forecast lower from 1.3% to 1.2% in September, although even this looks optimistic given consumer price growth registered a meagre 0.4% in September (Figure 11).

Figure 11: Eurozone Inflation Rate (2009 - 2016)

11.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Europe’s political landscape also remains uncertain, particularly with Britain’s pending exit from the European Union. Italy will go to the polls in its own historic constitutional referendum in December on a number of widespread political reforms. A defeat for Italy’s Prime Minister Matteo Renzi could open up the possibility of a new national election and increase support for the country’s Eurosceptic Five Star Movement Party.

We think that the escalating political problems in the Eurozone and the soon to be growing monetary easing stance from the European Central Bank should recommence the Euro’s downward path against almost every major currency. This will be particularly so against the US Dollar which we expect the single currency to reach parity with at some point in the first three months of next year.

 

 

EUR/USD

EUR/GBP

E-2016

1.04

0.83

Q1-2017

0.99

0.78

Q2-2017

0.97

0.76

Q3-2017

0.96

0.74

E-2017

0.95

0.73

E-2018

0.95

0.73

 

Japanese Yen (JPY)

The Japanese Yen has shown remarkable strength in the past few months, having so far been the best performing G10 currency in 2016. The currency has rallied almost 20% against the US Dollar so far this year amid growing uncertainty in financial markets following the Brexit vote and the failure of the Bank of Japan to announce any new significant easing measures (Figure 12).

Figure 12: USD/JPY (October ‘15 - October ‘16)

12.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The Bank of Japan (BoJ) has maintained its benchmark interest rate at -0.1% while leaving its large scale quantitative easing programme unchanged. Policymakers pledged in September the interest rate on 10-year government bonds will now be kept around zero, and the QE programme will run until inflation “exceeds” rather than reaches its 2% target.

Investors have remained unimpressed by the lack of any significant easing measures. Headline inflation has fallen sharply this year, having now been in negative territory for each of the past six months. Consumer prices fell deeper into negative territory in August, declining by 0.5%, its largest contraction since mid-2013 (Figure 13). BoJ inflation forecasts look increasingly optimistic and completely out of reach absent fresh stimulus measures and significant Yen depreciation.

Figure 13: Japan Inflation Rate (2010 - 2016)

13.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Economic growth for the second quarter was revised upwards slightly, although still remains weak with the economy growing by just 0.7% annualised in the three months to June. The IMF is now forecasting a paltry 0.5% expansion in the Japanese economy in 2016 and just 0.6% in 2017. There have, however, been some encouraging signs in the manufacturing industry with the manufacturing PMI now back above 50 and growing again for the first time in seven months. Industrial production also grew by 4.6% in the year to August, its largest expansion since early-2014 (Figure 14).

Figure 14: Japan Industrial Production (2013 - 2016)

14.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Bank of Japan Governor Kuroda has continued to open up the possibility of further expansion in monetary policy, reiterating in October that the BoJ “won’t hesitate to cut interest rates or expand asset purchases if necessary”. We think the bleak inflation outlook in Japan heaps further pressure on the BoJ to act when it next meets on 31 October-1 November. We expect to see some form of additional easing which could include a further cut in the main interest rate below the existing -0.1%.

An expansion in the Bank of Japan’s easing measures should, in our view, lead to sharp depreciation of the Yen from current levels against the US Dollar.

 

 

USD/JPY

EUR/JPY

GBP/JPY

E-2016

109

113

136

Q1-2017

113

112

144

Q2-2017

118

114

151

Q3-2017

119

114

155

E-2017

120

114

156

E-2018

120

114

156

 

Swiss Franc (CHF)

In line with our forecasts the Swiss Franc (CHF) has remained range bound between the 1.08-1.10 levels against the Euro in the third quarter of the year (Figure 15), as the Swiss National Bank (SNB) continues to prevent excessive appreciation of the currency. Following the Brexit vote in June the SNB intervened heavily in the FX market to weaken the Franc after the safe-haven currency surged to its strongest position in 10 months.

Figure 15: EUR/CHF (October ‘15 - October ‘16)

15.png

Source: Thomson Reuters Datastream Date: 28/10/2016

At the SNB’s monetary policy meeting in September the central bank reiterated the Franc remains “significantly overvalued” following the removal of the EUR/CHF currency ceiling in January 2015. Policymakers shrugged off recent criticism of its ultra-loose monetary policy stance, instead sticking to their pledge to make Swiss Franc investments less attractive in order to alleviate appreciating pressure on the currency. The central bank has maintained its negative interest rate at its record low -0.75%, while claiming that it continues to stand ready to intervene in the currency market.

Economic conditions in Switzerland have continued to warrant the use of an accommodative monetary policy stance. The strength of the Franc since the removal of the currency’s Euro cap in January 2015 has kept inflation negative in every month since mid-2014. However, the headline rate of inflation has improved in the past few months, with prices falling by just 0.1% in the year to August (Figure 16).

Figure 16: Switzerland Inflation Rate (2010 - 2016)

16.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The economy grew by an 2% year-on-year in the second quarter (Figure 17), and the IMF is now forecasting growth of just 1.5% in Switzerland in 2016 and 1.75% next year.

Figure 17: Switzerland Growth Rate (2010 - 2016)

17.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Recent communications from the Swiss National Bank have continued to make it clear that the central bank has no tolerance whatsoever for a stronger Franc. Persistently low inflation means the SNB is almost certain to maintain its ultra-loose monetary policy stance . We also expect SNB intervention in the FX market should the Franc show any signs of sustained appreciation from current levels against the Euro.

We therefore maintain our long standing forecasts for the Franc and expect to see a long term stabilisation of the currency around the 1.08 level against the Euro, which should ensure a gradual depreciation versus the US Dollar and Sterling.

 

 

USD/CHF

EUR/CHF

GBP/CHF

E-2016

1.06

1.08

1.30

Q1-2017

1.09

1.08

1.39

Q2-2017

1.11

1.08

1.43

Q3-2017

1.13

1.08

1.46

E-2017

1.14

1.08

1.48

 

Australian Dollar (AUD)

The Australian Dollar (AUD) was relatively well supported against the US Dollar in the third quarter of the year. A stabilisation in commodity prices (Figure 18) and slightly less dire economic news out of China allowed the currency to end the quarter higher against almost all of its G10 peers.

Figure 18: AUD/USD vs. Commodity Prices (2011 - 2016)

18.png

Source: Thomson Reuters Datastream Date: 28/10/2016

This strength came despite the Reserve Bank of Australia (RBA) easing its monetary policy again in August, cutting rates to a fresh record low 1.5% in a bid to prop up inflation, which is still below target, as well as a slowing jobs market.

The RBA kept its policy unchanged at its October meeting as was widely expected, and will now wait for additional evidence on the health of the economy, particularly the housing market, before reassessing the need for further cuts. A prolonged period of low rates in Australia is blamed for overheating the housing market.

Inflation has continued to remain stubbornly below the central bank’s 2-3% target, although rose unexpectedly to 1.3% in the third quarter of the year, after falling to its lowest level since the late-1990’s in the second quarter. This is in line with the minutes of the September meeting, which reiterated policy conditions were consistent with achieving the inflation target over time, and appeared to try to dampen expectations of further cuts.

Figure 19: Australia Inflation Rate (2006 - 2016)

19.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The recent rate cuts and stabilisation in commodity prices have provided a boost to growth. The Australian economy grew by a three year high 3.3% in the three months to July, helped in part by a moderate improvement in labour market conditions which has seen unemployment fall to its lowest level since 2013 (Figure 20). Consumer spending remains strong with a rebound in commodity prices sending exports higher. We think the economy should continue to post growth of around 3% in the coming quarters, particularly given the recent increase in commodity prices.

Figure 20: Australia Unemployment Rate (2010 - 2016)

20.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Australia’s economy has proved fairly resilient to external shocks so far this year. Barring any significant appreciation in AUD, we think this easing cycle in Australia has come to an end. We therefore expect a short term depreciation followed by stabilisation in the Australian Dollar against the US Dollar. However, AUD’s relative isolation from the economic and political troubles in the Eurozone would therefore lead to a fairly strong appreciation against the Euro.

 

 

AUD/USD

EUR/AUD

GBP/AUD

E-2016

0.74

1.41

1.69

Q1-2017

0.74

1.34

1.72

Q2-2017

0.73

1.33

1.75

Q3-2017

0.73

1.32

1.78

E-2017

0.73

1.30

1.78

 

New Zealand Dollar (NZD)

The New Zealand Dollar (NZD) carried forward its impressive performance in the first half of the year into the third quarter, with the currency rallying to its strongest position since May 2015 in September (Figure 21). A stabilisation in commodity and dairy prices has provided decent support for the currency while the Reserve Bank of New Zealand (RBNZ) disappointed investors in August by announcing just a modest cut in its benchmark interest rate.

Figure 21: NZD/USD vs. Commodity Prices (2013- 2016)

21.png

Source: Thomson Reuters Datastream Date: 28/10/2016

As we had anticipated, the RBNZ voted in favour of cutting its main rate again in August, lowering the rate for the fourth time in a year by 25 basis points to a fresh record low 2.0%. Central bank Governor Graeme Wheeler left the door firmly open to additional stimulus measures, claiming that “further policy easing will be required to ensure that future inflation settles near the middle of the target range”. They now anticipate at least one rate cut before the end of the year.

However, the market was left underwhelmed by the announcement in August, with investors eyeing up a 50 basis point reduction and a more aggressive signal for additional interest rate cuts in order to combat low inflation. Headline inflation registered a meagre 0.2% in the third quarter of the year, extending its run below one percent to the past eight quarters (Figure 22).

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

22.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Consumer prices have failed to show any sort of meaningful turnaround despite the series of interest rate cuts, with price growth remaining around its lowest level in 16 years. The relative strength of NZD and the still low commodity prices means that inflation is now not expected to return back to its 2% target until the third quarter of 2018 – 9 months later than originally expected.

On a more positive note, the economy continues to grow at a very healthy pace, with GDP expanding by 3.6% in the second quarter of the year (Figure 23). Growth is expected to accelerate further, bolstered by record low interest rates and a stabilisation in dairy prices, New Zealand’s largest export earner.

Figure 23: New Zealand Annual GDP Growth Rate (2010 – 2016)

23.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Despite this, the RBNZ has explicitly voiced its desire for a weaker currency and now looks firmly on course to continue cutting interest rates in the coming months in a bid to tackle to anaemically low inflation in the country. New lending restriction introduced in September should help cool the housing market, thus providing room for further easing of monetary policy.

We think that the divergence in monetary policy stance between that of the RBNZ and the Federal Reserve, as well as the explicit RBNZ wish for currency depreciation should ensure a gradual depreciation of NZD against the US Dollar from current levels.

 

 

NZD/USD

EUR/NZD

GBP/NZD

E-2016

0.68

1.53

1.84

Q1-2017

0.67

1.48

1.90

Q2-2017

0.66

1.47

1.94

Q3-2017

0.65

1.48

2.00

E-2017

0.65

1.46

2.00

 

Canadian Dollar (CAD)

The Canadian Dollar (CAD) has weakened steadily against the USD since mid-2016. CAD rallied sharply in the first quarter of the year amid a weak US Dollar and a recovery in oil prices, of which accounts for a full quarter of Canada’s overall export revenue. It is therefore no surprise that the currency has followed a remarkably similar trend to oil prices, which saw CAD plunge to a 13 year low in January (Figure 24). However, this tight relationship has weakened somewhat lately, and the Canadian Dollar has depreciated against the US Dollar even as oil prices have trended up.

Figure 24: CAD/USD vs. Crude Oil Prices (2014 - 2016)

24.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The Bank of Canada (BoC) held fire from cutting its benchmark interest rate in October, keeping rates unchanged at 0.5% for the tenth straight meeting despite warning that risks to inflation had tilted to the downside since its July meeting. Headline inflation declined to a ten month low 1.1% in August, while the core measure slumped to its lowest level in more than two years, falling sharply to 1.8% from 2.1%. Inflation in Canada has been on a gradual downtrend in the past few months as the effect of a weak Dollar fades out of the index.

Canada’s economy also contracted in the second half of the year by 0.4% with the BoC sighting a slowdown in the global economy during the three months to July. Mass wildfires in the oil-rich Alberta caused the oil and gas industry to slow in May, while exports suffered from their largest quarterly drop since early-2009. Canada’s balance of trade subsequently registered a record high deficit in June (Figure 25), which bodes ill for the country’s already negative current account balance.

Figure 25: Canada Trade Balance (2000 - 2016)

25.png

Source: Thomson Reuters Datastream Date: 28/10/2016

BoC Governor Stephen Poloz claimed in September that it could now take the economy between 3-5 years to recover back to normal following the oil price shock. However, the central bank still expects a substantial rebound in the second half of the year, which could alleviate pressure on the BoC to rush to cut interest rates again.

The shift to a slightly more dovish tone from the BoC in September suggests that any rate hikes are a long way into the future. We therefore maintain our forecasts for a gradual depreciation of CAD from current levels against the US Dollar.

 

 

USD/CAD

EUR/CAD

GBP/CAD

E-2016

1.32

1.37

1.65

Q1-2017

1.34

1.33

1.70

Q2-2017

1.35

1.31

1.73

Q3-2017

1.40

1.34

1.82

E-2017

1.45

1.38

1.90

 

 

Swedish Krona (SEK)

Sweden’s central bank, the Riksbank, has maintained its expansionary monetary easing stance this year as it attempts to increase inflation, reduce the risk of a Krona appreciation and lower unemployment. The central bank’s aggressive easing policy has caused the Krona to be the worst performing G10 currency so far in 2016 barring Sterling (Figure 26) with the currency slumping to a 6-and-a-half year low against the Euro and 7 year trough versus the Dollar in October.

Figure 26: EUR/SEK (October ‘15 - October ‘16)

26.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The Riksbank has maintained its historic low interest rate deep in negative territory at -0.5% since rates were lowered by 15 basis points back in February 2016, while remaining committed to purchasing government bonds throughout the second half of the year. The central bank’s quantitative easing programme will amount to a massive 245 billion SEK at the end of 2016.

Rhetoric from the Riksbank turned more dovish in October following a noticeably more upbeat message at the September meeting. The central bank now does not expect to start raising rates until early 2018, six months later than planned, while saying it was “ready to extend” its QE purchases in December.

Efforts to boost inflation in Sweden appear to have faltered, with headline consumer price growth registering a lower-than-expected 0.9% on a year previous in September (Figure 27). This has called into question the central bank’s view that inflation is expected to trend higher, and could cause the Riksbank to ease monetary policy further in the coming months.

Figure 27: Sweden Inflation Rate (2010 - 2016)

27.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Despite the heavy pressure on the Riksbank to ease further, Sweden’s economy continues to grow at a steady clip, expanding at an enviable 3.4% in the second quarter of the year. Consumer spending has grown at a very healthy pace so far this year and has offset a worsening in the country’s balance of trade. The labour market is also improving and unemployment has been on a downward trend in the past few years, reaching a near seven year low 6.3% in July (Figure 28).

Figure 28: Sweden Unemployment Rate (2010 - 2016)

28.png

Source: Thomson Reuters Datastream Date: 28/10/2016

The Riksbank has remained wary of developments abroad at recent meetings, namely Brexit and weakness in the European banking system. The bank’s October statement reiterated the Riksbank’s willingness and ability to do more if necessary, although it will no doubt be wary of overstimulating the housing market which has seen house prices double in the past decade (Figure 29).

Figure 29: Sweden Real Estate Price Index (2000 - 2016)

29.png

Source: Thomson Reuters Datastream Date: 28/10/2016

In spite of the Riksbank’s aggressive stimulative stance, we think that the sell-off in the Krona has been excessive. The economy is performing well, and the recent dip in inflation will prove temporary, particularly as the effects of the weaker currency filter through to domestic prices. We therefore expect significant Krona strength against the Euro, though we are pushing back our timetable for appreciation in view of recent events.

 

 

USD/SEK

EUR/SEK

GBP/SEK

E-2016

9.45

9.85

11.85

Q1-2017

9.70

9.60

12.30

Q2-2017

9.60

9.30

12.30

Q3-2017

9.60

9.20

12.45

E-2017

9.50

9.00

12.30

 

Norwegian Krone (NOK)

The Norwegian Krone (NOK) has rebounded strongly since falling to a 14 year low in January, reversing much of its recent depreciation and ending the third quarter as the best performing G10 currency. This follows the recovery in oil prices (Figure 30), Norway’s chief export, and a shift to a less dovish tone from the country’s central bank, Norges Bank.

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

30.png

Source: Thomson Reuters Datastream Date: 28/10/2016

NOK strengthened by over 4% against the US Dollar in September alone after Norges Bank wrong-footed investors by abandoning its base-case scenario for an additional rate cut it has held since December last year. The central bank reiterated at its October meeting that interest rates are likely to remain close to the existing 0.5% level for the foreseeable future following unexpectedly strong inflation data and growing optimism over the health of the domestic economy. 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.

Low oil prices have been the primary driver of the Norwegian economy’s underperformance, forcing Norges Bank to slash its benchmark interest rate by 100 basis points in the past two years. However, a recovery in oil prices to back around $50 a barrel and a stronger-than-expected pass-through effect from the weaker currency caused the economy to expand by a much improved 2.5% in the second quarter.

Norway’s manufacturing sector has picked up pace in the past few months, with the manufacturing PMI now finally back above the level of 50 that denotes positive growth (Figure 31). Mining production also experienced a rare month of growth in July, notching its largest monthly expansion in over a year. The record low interest rate and weak Krone has also continued to provide a boost to inflation, which increased to a seven year high 4.4% in July.

Figure 31: Norway Manufacturing PMI (2013 - 2016)

31.png

Source: Thomson Reuters Datastream Date: 28/10/2016

Despite the recent recovery in oil prices, exports have continued to decline with the country’s trade surplus edging towards its lowest level since 2001. Weaker demand in the oil industry has also lowered manufacturing production, while consumer spending still remains fairly sluggish.

Norges Bank’s surprisingly optimistic assessment of the economy in both September and October, and its shift away from additional rate cuts, means we continue to expect a modest appreciation of NOK against the Euro and a gradual depreciation against the US Dollar.

 

 

USD/NOK

EUR/NOK

GBP/NOK

E-2016

8.65

9.00

10.80

Q1-2017

9.00

8.90

11.40

Q2-2017

9.12

8.85

11.70

Q3-2017

9.15

8.80

11.90

E-2017

9.15

8.70

11.90

 

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 so far this year. Speculation that the DNB could abandon its long-standing currency peg has now all but evaporated as pressure on the Euro peg abates.

Foreign exchange reserves have remained relatively stable in the past few months, with the DNB not intervening in the foreign exchange market in either July or August. Reserves remained essentially unchanged at 450 billion DKK in August (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)

32.png

Source: Thomson Reuters Datastream Date: 28/10/2016

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 so far this year.

The DNB has maintained its interest rate deep in negative territory at -0.65% for the past 10 months, having raised rates in January 2016. While rates are likely to remain below zero for the foreseeable future the central bank could 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

E-2016

7.15

7.46

9.00

Q1-2017

7.55

7.46

9.55

Q2-2017

7.70

7.46

9.85

Q3-2017

7.77

7.46

10.10

E-2017

7.85

7.46

10.20

 

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