G10 FX Forecast Revision – Q3 2016

Print Friendly and PDF

Sterling plummets after Britain votes to leave the European Union

Financial markets reacted badly to Britain’s unexpected decision to vote in favour of leaving the European Union in June. This is perhaps the most significant political event in Europe in the last few decades and has led to one of the most volatile and uncertain periods of currency trading in recent memory.

The Pound went into free fall on the back of the news, suffering from its worst one-day depreciation against the US Dollar in history, having fallen by over 10% in a matter of hours. Sterling plunged to multi-year lows against every G10 currency, declining to its weakest position against the Dollar since 1985, while falling sharply to its lowest level against the Euro since March 2014 (Figure 1).


Figure 1: Sterling vs. USD & EUR (16/06/16 - 01/07/16)

Source: Thomson Reuters Datastream Date: 01/07/2016

Investors reacted in unsurprising fashion, piling into safe-haven currencies and away from risky assets. The Japanese Yen rallied sharply below 100 to the USD for the first time in two-and-a-half years, while appreciating by a massive 15% against Sterling. The safe-haven Swiss Franc has also strengthened, with the US Dollar recovering around a half of its losses since the beginning of the year.

Emerging market currencies sold-off heavily on the day, although have been surprisingly resilient and performed relatively well in the face of such a significant market event.

The reaction of central banks to the turmoil and uncertainty is now key. The Bank of England launched a raft of aggressive easing measures at the beginning of August, cutting its benchmark interest rate to a record low 0.25% while increasing its quantitative easing programme by £60 billion.

The European Central Bank is also looking increasingly likely to ramp up its easing measures in the coming months. Interest rate markets appear to have ruled out entirely the possibility of a hike before early-2017.

We have seen signs of a tentative stabilisation in markets since the vote. Sterling seems to have found a temporary floor in the 1.30-1.35 range against the US Dollar, even after the Bank of England cut its interest rate. Worldwide stock markets as a whole have regained their mid-June levels. The FTSE 100 UK index is actually above the pre-referendum levels, though of course this doesn’t take into account the significant haircut taking by the currency in which those stocks are denominated.

We think that the evolution of the G10 currencies in the coming weeks and months will depend heavily on both the political and economic fallout from June’s shock Brexit result, and indeed the reaction from the major central banks as they seek to reinstall calm and stability back into financial markets.

The significant revisions to our currency forecast after the referendum assumes our central scenario for the referendum fallout:

  • We expect the negotiating process to be long and protracted, and few if any actual changes will take place for many years.
  • Britain will end up retaining access to the single market in some form, in return for concessions elsewhere.
  • Central bank easing will help stabilise financial markets not far from current levels.
  • There will be a significant downturn in UK investment for the next two quarters, while decision makers wait for uncertainty to dissipate somewhat. Also, there will be a sustained decrease in imports into the UK on the back of consumer uncertainty and the lower Pound.

 

UK Pound (GBP)

Britain stunned strategists and financial markets in June by unexpectedly voting in favour of leaving the European Union, causing one of the most dramatic major currency movements in recent history.

Contrary to a string of opinion polls the week before the vote, the British public defied the odds and voted 52% to 48% in favour of leaving the EU, the first instance in its history. Financial markets around the world were rocked, with the Pound experiencing its largest ever one-day decline, falling in excess of 10% against the US Dollar to its weakest position against the Greenback since 1985. In trade-weighted terms, the currency has fallen to its lowest level since March 2013 (Figure 2).


Figure 2: Sterling Effective Exchange Rate (2013 – 2016)

Source: Thomson Reuters Datastream Date: 05/08/2016

The UK will continue to enjoy membership of the EU in the short term, and no significant legislative changes will take place for quite a long period of time. Activation of Article 50, which would set the two-year clock ticking on the UK’s exit from the EU, is not expected to take place any time soon. It is unclear whether the Conservative’s will have enough party support to do it and it’s quite possible that Parliament approval would be needed, throwing yet another obstacle in the way.

The political situation in the UK is also uncertain, with Theresa May announced as the new Prime Minister following David Cameron’s resignation. The SNP in Scotland has also strongly indicated that it will pursue a second Scottish independence referendum, with early polls suggesting that support has risen following the Brexit result. 

In order to prevent an economic downturn from taking hold in the UK, the Bank of England’s MPC voted unanimously in August to cut its benchmark interest rate by 25 basis points to a fresh record low 0.25%, while ramping up its quantitative easing programme by £60 billion to £435 billion. billion. Moreover, the Bank of England will now buy up to £10 billion of corporate debt, while launching a new ‘Term Funding Scheme’ of up to £100 billion in order to ensure commercial banks pass on the full rate cut to their borrowers. This means the Bank of England could now pump as much as a massive £170 billion into the UK economy.

These easing measures are very significant in nature and much more aggressive than the vast majority of economist had anticipated. The shift in tone for the Bank of England in the past few months is clear and we think that further easing measures could be on the way should the next few months’ PMI and growth figures fail to show any meaningful turnaround. Governor Carney even claimed as much by warning the Bank would take ‘whatever action is needed’, which could include an additional rate cut to zero.

The Bank of England’s decision to increase easing measures came as no real surprise following July’s abysmal PMI figures. The manufacturing and services PMIs both fell sharply, down to below the critical level of 50 that denotes contraction. The manufacturing sector suffered its worst month since February 2013, while the UK’s dominant services industry, which accounts for almost 80% of overall economic output, plunged by the most since records began in 1996, slumping to a seven year low of 47.4 (Figure 3).

Figure 3: UK Purchasing Managers Indexes (PMI’s) (2014 – 2016)

Source: Thomson Reuters Datastream Date: 05/08/2016

We now expect flat growth in the second quarter, a 1% QoQ SAAR contraction in UK GDP growth in the third quarter, and yet another quarter of flat growth in the fourth quarter. Overall, we think that the UK will just barely avoid a technical recession, as improvements in the trade deficit and Government spending partly offset the hit to investment and consumption. However, 2016 economic growth as a whole will likely be flat.

As for inflation, the feed through of a 10% drop in Sterling should amount to about 1%, though not all of it will be felt right away. We expect headline CPI inflation to hit about 0.8% by year end 2016 and continue increasing towards 2.5% in 2017.

Following Britain’s shock exit from the EU, we are revising our Sterling forecasts sharply lower against every G10 currency.

 

GBP/USD

GBP/EUR

Q3-2016

1.30

1.25

E-2016

1.29

1.33

Q1-2017

1.30

1.35

Q2-2017

1.30

1.37

E-2017

1.30

1.37

 

US Dollar (USD) 


The US Dollar has recovered around half of its year-to-date losses since Britain voted to leave the European Union, with safe-haven flows into the currency making up for a rather poor few months for the Dollar.

Even prior to the UK’s referendum, financial markets had been pushing back their expectations for the next interest rate hike in the US, especially following June’s labour report which was a massive disappointment.

Nonfarm payrolls increased by a revised 11,000, the smallest gain in the measure since September 2010 (Figure 4). Even taking into account the month long strike by telecoms firm Verizon, of which struck 34,000 off the final figure, this was significantly less than anticipated. However, the situation has improved somewhat, with July’s figure a much more respectable 287,000. Average earnings remained unchanged, while unemployment was just shy of a nine year low 4.8%.

Figure 4: US Nonfarm Payrolls (2010 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

We expect the US economy to weather the turmoil relatively better than any other major economy, due to its relative isolation from global trade (exports make up just 15% of its GDP) and the fact that US assets appear to be behaving as safe havens. As this is written, US stocks have recovered all of their post-referendum losses.

However, it seems clear that the Fed will be even more cautious in hiking rates until it gets a better picture of the fallout from the referendum results. It is now uncertain whether the Fed will be able to keep pace with its own interest rate projections from the FOMC’s June meeting, which were already revised downwards fairly significantly from its March projections. We now expect just one hike from the Federal Reserve this year at the December meeting, and just two or three more in 2017.

A delay in both the pace and timing of Federal Reserve interest rate hikes this year should, in our view, be compensated by safe-haven flows into the US Dollar. Furthermore, the gap between economic performance and monetary policy between the US and European economies is likely to widen further as a result of the referendum results.

We therefore have revised higher our forecasts for a US Dollar appreciation against both the Euro and in particular Sterling.

 

EUR/USD

GBP/USD

Q3-2016

1.04

1.30

E-2016

0.97

1.29

Q1-2017

0.96

1.30

Q2-2017

0.95

1.30

E-2017

0.95

1.30

 

Euro (EUR) 

Recent economic developments in the Eurozone have been completely overshadowed by Britain’s decision to quit the European Union in June, and rightly so. Following the UK’s vote to leave the bloc, the Euro fell sharply by around 4% against the US Dollar to its weakest position since early March, while European stocks posted their largest daily drop in eight years.

However, we think that the fallout in the Eurozone has been underestimated somewhat and we’re already seeing calls in other European countries for a similar referendum, most notably in the Netherlands, France and Italy. The risk of contagion in the rest of the European Union is considerable and a number of senior European officials, including EU President Donald Tusk, have attempted to speed up exit negotiations in order to prevent populist parties from taking hold.   

We think that the referendum result will also ramp up further pressure on the European Central Bank to increase its economic stimulus measures in the coming months. The ECB keep its monetary policy unchanged at its June meeting, although insisted that the central bank was ready, willing and able to increase stimulus if the current measures fail to increase both growth and inflation in the Eurozone.

Headline inflation in the Euro-area remained in negative territory in May, falling by 0.1% on an annualised basis (Figure 5). Consumer prices in the Eurozone have now failed to grow for the past four months despite the ECB cutting its main refinancing rate to zero and increasing its quantitative easing programme to 80 billion Euros a month in March.

Figure 5: Eurozone Inflation Rate (2013 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

Growth in the Eurozone also appears to be slowing. The latest PMI’s are now trending downwards, with the crucial composite PMI falling to its lowest level in a year-and-a-half in June (Figure 6). As is the case of the UK, the first real measure of the negative economic and financial fallout from the Brexit will come in the investor and business manager confidence surveys out on 22 July.


Figure 6: Eurozone Purchasing Managers Indexes (PMI’s) (2014 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

While slower than expected interest rate hikes by the Federal Reserve in the US should alleviate some pressure on the Euro, we think that the enhanced political risks (such as the constitutional referendum in Italy this fall) and the high likelihood of additional easing measures by the European Central Bank should see the common currency trend considerably lower over the next weeks and months.

 

EUR/USD

EUR/GBP

Q3-2016

1.04

0.80

E-2016

0.97

0.75

Q1-2017

0.96

0.74

Q2-2017

0.95

0.73

E-2017

0.95

0.73

 

Japanese Yen (JPY)


The Japanese Yen has strengthened sharply in the first half of the year, with growing uncertainty in financial markets leading to mass inflows into the safe-haven currency.

Following Britain’s vote to leave the EU, the Yen dipped below 100 USD for the first time in two-and-a-half years, rallied to a more than three year high against the Euro and appreciated by a massive 15% against Sterling overnight. The Yen has appreciated a whopping 17% in trade-weighted term so far in 2016.

Despite the Yen’s recent sharp appreciation, Japanese authorities have continued to surprise the markets by their lack of additional monetary easing measures, and have as yet not officially intervened in the currency market in order to weaken the Yen.

A strong Yen bodes ill for the country’s heavily export oriented economy, and is something that policymakers in the country will be actively seeking to avoid. A number of senior officials in Japan, including Prime Minister Shinzo Abe, have claimed that the country won’t hesitate to respond if needed.

The recent sharp rally in the Yen has defied the relatively poor economic fundamentals in the Japanese economy, which continue to disappoint. The world’s third largest economy has stagnated, barely growing over the past few quarters due to weak demand both domestically and abroad. GDP expanded by just 0.5% in the first quarter of the year, 1.9% annualised, making it one of the worst performers among the G10 (Figure 7).


Figure 7: Japan GDP Growth Annualised (2013 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

Exports have fallen rather sharply, declining for the eighth consecutive month in May to their lowest level in over three years. This is a significant issue for the economy, given exports account for around one-fifth of overall GDP. Consumer spending also remains weak, while industrial production has fallen in every month since mid-2015.     

Headline inflation has also taken another turn for the worse, declining by 0.3% in the year to April (Figure 8) and remaining considerably below the Bank of Japan’s 2% inflation target. The BoJ’s move to cut its main interest rate into negative territory in January appears to have done little to stimulate price growth, which is now not expected to reach its target until sometime in fiscal 2017.

Figure 8: Japan Inflation Rate (2014 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

We think that the turmoil following the UK referendum will finally force the Bank of Japan’s hand. We expect new easing measures in the coming months. Further, we expect to see intervention if the Yen appreciates to a level less than 100 to the Dollar in any sustained manner.

Therefore, we think that the balance of risks are skewed toward a rather pronounced Yen depreciation against the US Dollar from current levels.

 

USD/JPY

EUR/JPY

GBP/JPY

Q3-2016

110

114

143

E-2016

115

112

149

Q1-2017

117

112

152

Q2-2017

120

114

156

E-2017

120

114

156

 

Swiss Franc (CHF)

The Swiss National Bank (SNB) has continued to prevent an excessive appreciation of the Swiss Franc in the past few months, intervening heavily in order to protect the safe-haven currency following Britain’s exit from the EU.

Following June’s unexpected Leave vote, the Franc rose to its highest level against the Euro since August 2015, although it appears to have stabilised after the SNB official announced it intervened and would remain active in the FX market. The SNB has also maintained its negative interest rate at -0.75% in a bid to alleviate appreciating pressure on the Franc, which it reiterates is still “significantly overvalued”.

The strength of the Franc since the removal of the currency’s Euro cap in January 2015 has complicated efforts to boost inflation in Switzerland, which has remained negative in every month since mid-2014. Headline inflation has improved in the past few months, although was unchanged at -0.4% in May (Figure 9).


Figure 9: Switzerland Inflation Rate (2013 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

The SNB has continued to revise downward its inflation expectations, in what has become a regular event. The June meeting was the first one in a long time in which it did not do so. However, this meeting took place before the UK referendum.


We expect the SNB to revise growth and inflation projections downward yet again in September, and we also expect another cut in interest rates to an unheard of -1.00% on sight deposits. The economy remains fragile due to the Franc’s strength and weak demand from abroad and the central bank has subsequently come under pressure to ease monetary policy further.

We think it is clear that the Swiss National Bank has no tolerance for a strong Franc, and would expect the SNB to continue intervening should CHF approach 1.06 against the Euro, much like it did following last month’s Brexit.

We therefore maintain our forecasts for the Franc to remain stable at around the 1.08 level against the Euro, which should ensure a gradual depreciation versus the US Dollar.

 

USD/CHF

EUR/CHF

GBP/CHF

Q3-2016

1.04

1.08

1.35

E-2016

1.11

1.08

1.44

Q1-2017

1.13

1.08

1.46

Q2-2017

1.14

1.08

1.48

E-2017

1.14

1.08

1.48

 

Australian Dollar (AUD) 

The Australian Dollar (AUD) rebounded in June on the back of a general improvement in investors risk appetite. While the latter was entirely reversed by the shock result of the referendum in the UK, AUD has reacted relatively well since, holding on to most of its June gains against the US Dollar and has rallied strongly against the Euro and, of course, Sterling.

The currency has also weathered well the hung result of the Federal Election on 2 July, in a sign that markets are much more focused on the international fallout and, specially, the fallout from Brexit.

Domestic conditions were strong in the first half of 2016. GDP rose to a three year high 3.1% in the first quarter (Figure 10), with a rebound in commodity prices sending exports higher. Consumer spending also increased to its highest level since 2012. Policymakers expect growth to strengthen further over the next couple of years as the negative effect of the waning resources investment boom softens.

Figure 10: Australia Annual GDP Growth (2011 - 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

Despite the rebound in economic growth, the RBA remains far more concerned with below target inflation. Inflation fell again in the first quarter of the year to a four year low 1.3%, well below the 2-3% inflation target. Headline inflation in Australia is now expected to remain low for “some time”. Even before the UK referendum roiled markets, we saw a good chance of a cut in the repo rate which came at the central bank’s August meeting. Rates were cut by 25 basis points to a record low 1.5%, with the RBA warning that more cuts could be on the horizon.

The prospect of lower rates in Australia, coupled with still weak demand from China and low commodity prices, should ensure a gradual depreciation of AUD against the US Dollar from current levels over the remainder of the year.

However, the underlying strength of the Australian economy, still forecast to grow above 3% for the next 18 months, together with its relative isolation from European troubles stemming from Brexit, means that it will probably appreciate strongly against the Euro.

 

AUD/USD

EUR/AUD

GBP/AUD

Q3-2016

0.74

1.41

1.76

E-2016

0.73

1.33

1.77

Q1-2017

0.72

1.33

1.80

Q2-2017

0.71

1.34

1.83

E-2017

0.70

1.36

1.86

 

New Zealand Dollar (NZD) 

The New Zealand Dollar (NZD) performed well in the first half of 2016, weathering aggressive monetary easing from the Reserve Bank of New Zealand (RBNZ) and the Brexit vote. On the eve of Britain’s referendum, NZD even rallied to its strongest position in thirteen months. Although it dipped modestly in the referendum immediate aftermath, it soon managed to rally to fresh highs against almost every other major currency.  

The RBNZ has decided against cutting interest rates in the past few months, primarily due to the recent sharp increase in house prices in the country. This follows a surprise cut in the benchmark rate by 25 basis points to 2.25% in March, with policymakers citing slower growth in China, declining inflation and the need for a weaker currency. However,  worries that the rise in house prices  are becoming a threat to financial stability stayed Governor Wheeler’s hand and rates were unchanged again in June.

Economic growth in the first quarter of the year was impressive, with the economy growing by 2.8% on an annualised basis, its fastest rate of growth in a year. Growth is expected to accelerate throughout the remainder of 2016, bolstered by record low interest rates and a stabilisation in global dairy prices, of which account for around 40% of the country’s overall export revenue.  

However, inflation in New Zealand has failed to show any meaningful signs of a pick-up despite the aggressive monetary easing from the RBNZ. Headline consumer price growth grew by just 0.4% in the first quarter of the year (Figure 11), which remains around its weakest level in 16 years, and considerably below the central bank’s 2% inflation target. The RBNZ is now not expecting inflation to return to its target until early 2018.  

Figure 11: New Zealand Inflation & Dairy Prices (2010 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

Considering the persistently weak inflation and downside risks to growth following the Brexit vote, we see a very good chance that the Reserve Bank of New Zealand could follow the RBA and announce a further 25 basis point cut at its August meeting.

The likelihood of additional rate cuts in New Zealand this year would widen the divergence in monetary policy stances between the Federal Reserve and the RBNZ, and should ensure the New Zealand Dollar recommences its depreciating trend against the USD in the coming months. However, we are revising our forecasts for NZD higher, given the recent unexpected strength in the currency.

 

NZD/USD

EUR/NZD

GBP/NZD

Q3-2016

0.70

1.49

1.86

E-2016

0.68

1.43

1.90

Q1-2017

0.67

1.43

1.94

Q2-2017

0.66

1.44

1.97

E-2017

0.66

1.44

1.97

 

Canadian Dollar (CAD)

The Canadian Dollar (CAD) recovered well from its multi-year lows in the first half of 2016 in line with a weak US Dollar and a rebound in global oil prices. Oil accounts for a full quarter of Canada’s overall export revenue. The currency rallied to its strongest position in ten months in May with oil prices edging back above $50 a barrel for the first time since November (Figure 12).


Figure 12: CAD/USD vs. Crude Oil Prices (2015 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

Economic growth in the first quarter of the year picked up slightly, although came in at a much less-than-expected 1.1% year-on-year (Figure 13).


Figure 13: Canada Annual GDP Growth (2011 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016


The outlook for the second quarter is less optimistic, with mass wildfires in the oil-rich Alberta expected to shave as much as 1.25% off real GDP. Consumer spending has slowed, job growth stalled, while the country’s trade deficit ballooned to a record high in March after exports dipped to a two year low. The country’s terms of trade recently declined to its lowest level since 2003.

Headline Inflation has also slowed, falling back to a below target 1.5% in May. The Bank of Canada (BoC) has continued to keep its benchmark interest rate unchanged, although weak price growth and the prospect of softer external demand following last month’s Brexit suggest that a normalisation in interest rates remains some way off.

However, the government’s large scale fiscal stimulus package, which could see as much as 10 billion CAD spent in the next two fiscal years, has lessened the need for another cut and financial markets are now not pricing in any changes in monetary policy throughout the rest of the year.

Furthermore, the Bank of Canada sounded a distinctly less dovish tone at its July meeting. In addition to leaving rates unchanged, it made explicit its serious worries about the housing bubble developing in Vancouver and Toronto.

It is clear to us that the easing cycle in Canada has come to an end, and absent a collapse in oil prices, the next move in rates is likely to be up. We therefore revise upwards our forecasts for the Canadian Dollar.

 

USD/CAD

EUR/CAD

GBP/CAD

Q3-2016

1.30

1.35

1.69

E-2016

1.32

1.28

1.71

Q1-2017

1.34

1.29

1.74

Q2-2017

1.35

1.29

1.76

E-2017

1.45

1.38

1.89

 

Swedish Krona (SEK) 

Sweden’s central bank, the Riksbank, has maintained its aggressive monetary easing stance this year as it attempts to increase inflation, reduce the risk of a Krona appreciation and lower unemployment.

Policymakers in Sweden have kept the country’s negative interest rate, which was lowered by 15 basis points to -0.5% in February, and maintained its large scale quantitative easing programme. The Riksbank will purchase a further 45 billion SEK during the second half of 2016, meaning that asset purchases will now total a massive 245 billion SEK by the end of the year.

These efforts to boost inflation in Sweden appear to be working well. Headline inflation increased above the central bank’s expectations to a four year high 0.8% in April, although is still expected to undershoot its target in 2016.

Sweden’s economy also continues to grow far in excess of many of its major peers, expanding by 4.2% in the first 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. This could alleviate some pressure on the central bank to act further.

However, the Riksbank struck a dovish tone at its 5 July meeting. While no further cuts in the interest rate were announced, the Bank made it clear that it is ready to intervene in the foreign exchange market in order to prevent a too rapid appreciation of SEK. Further, it reiterated its worry about the rapid rise in house prices and mortgage-driven household indebtedness. Real prices have soared in the past two years, with the retail price index almost doubling in the past decade (Figure 14).


Figure 14: Sweden Real Estate Price Index (2006 - 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016


Given its concern about house price inflation in Sweden, the main monetary easing tool still open to the Riksbank is the FX rate. Consequently, we revise down our forecasts for the Krona against all currencies save the Pound.

 

USD/SEK

EUR/SEK

GBP/SEK

Q3-2016

8.9

9.3

11.6

E-2016

9.5

9.2

12.3

Q1-2017

9.6

9.2

12.4

Q2-2017

9.6

9.1

12.5

E-2017

9.5

9.0

12.3

 

Norwegian Krone (NOK) 


In line with the rebound in oil prices since the beginning of February, the Norwegian Krone has remained relatively stable against the US Dollar, having earlier in the year fallen to a 14 year low against the USD (Figure 15).

Figure 15: NOK/USD vs. Oil prices (2015 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016


Low oil prices have been the primary driver of NOK underperformance. Although the Oil Fund does an effective job of isolating consumer demand and Government spending from oil price fluctuations, the Norwegian economy is still exposed to oil because of the importance of capital investment in oil projects in the economy.


However, Norway’s central bank, Norges Bank, has kept its benchmark interest rate unchanged since it cut rates to 0.5% in March, signalling in June that it intends to deliver less monetary stimulus this year in light of the oil price rebound. While it didn’t rule out another cut this year, its assessment of the domestic economy was relatively upbeat and it appears to have backtracked on its assessment that rates could turn negative.


It must be noted that the June meeting took place just before the referendum. However, oil prices have not moved much since then, so it is unclear whether Norges Bank will change its assessment at the September meeting.


The record low interest rate has provided a boost for inflation, which rose to a seven year high 3.4% in May. This remains an enviable level compared to most of its major peers. Economic growth also improved in the first quarter of the year, although remains very weak, with the economy growing by just 0.7% in the first quarter.


Despite the recent recovery in oil prices, exports fell by 1.2% in Q1 with the country’s trade surplus now approaching its lowest level since 2001. Weaker demand in the oil industry has also lowered manufacturing production, while consumer spending remains sluggish.


Recent stability in oil prices and the receding need for an interest rate cut in Norway should provide decent support for NOK against the Euro and we would therefore expect the Krone to experience a gradual appreciation versus the single currency over the next eighteen months. This, in our view, would lead to no more than a slight depreciation versus the US Dollar.

 

USD/NOK

EUR/NOK

GBP/NOK

Q3-2016

8.75

9.10

11.40

E-2016

9.28

9.00

12.00

Q1-2017

9.28

8.90

12.05

Q2-2017

9.30

8.85

12.10

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 continued to decline in the past few months after peaking last year following attempts to prop up the Krone. FX reserves fell to a six year low 407 billion DKK in April (Figure 16), around 20% of GDP and a considerable 40% lower than their peak following the removal of the Swiss Franc cap in January 2015. This is despite the central bank intervening in the currency market in May for the first time in three months.


Figure 16: Denmark FX Reserves (2012 – 2016)

Source: Thomson Reuters Datastream Date: 13/07/2016

The DNB has even had room to raise its main interest rate at the beginning of the year, hiking by 10 basis points to -0.65% where they have been held ever since. The decision to ignore interest rate cuts by the European Central Bank and hold rates steady in the past few months further points to lessening pressure on the peg, given the interest rate spread with the Eurozone remains the most important tool in defending the DKK exchange rate.


Policymakers in Denmark have reiterated that they have limitless scope to protect the Krone’s peg and deter another speculative attack on the currency’s exchange rate regime in the future. We therefore expect the 7.46 peg to the Euro to remain in place for the foreseeable future.

 

USD/DKK

EUR/DKK

GBP/DKK

Q3-2016

7.20

7.46

9.35

E-2016

7.70

7.46

9.95

Q1-2017

7.77

7.46

10.10

Q2-2017

7.85

7.46

10.20

E-2017

7.85

7.46

10.20

 

 

 

 

Have more questions? Submit a request