Euro Forecasts Upgraded at Deutsche Bank, says ECB to Hike Rates in December

"Our strategists would expect EUR/USD to rise materially above 1.20 by next year" - Deutsche Bank.

Image © European Central Bank, reproduced under CC licensing

The European Central Bank (ECB) will raise interest rates in December says Deutsche Bank, a call that could offer Euro exchange rates support going forward.

Deutsche Bank's Chief Economist Mark Wall says he now expects the ECB to initiate policy rate liftoff with a 25bp hike in December 2022.

The call is in line with investor expectations, as implied by money markets, for a rate rise by year-end.

"If our baseline ECB forecast materialises without an acceleration in our projected Fed hiking cycle, our strategists would expect EUR/USD to rise materially above 1.20 by next year," says Wall.

Above: "Deposit rate to reach 1% by end-2024, at which time the ECB can initiate bond-based QT" - Deutsche Bank.

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Deutsche Bank had previously held a base-case expectation for a 10 basis point hike in December 2023, informing expectations for Euro weakness in 2022.

Expectations for a December rate hike come amidst rising Eurozone inflation which is now running well ahead of the ECB's official target rate. Eurozone annual inflation was 5.0% in December 2021, up from 4.9 % in November 2021.

"After the latest upgrading of our HICP inflation forecasts, the ECB’s 'triple lock' liftoff criteria are set to be met earlier than previously anticipated. Inflation is still expected to decline in 2022, but more slowly and not as far," says Wall.

A December rate hike would mean the gap between the ECB and other central banks that have raised rates already, or are entering a rate hike cycle, closes.

For currencies this matters as it offers some yield support for the Euro.

"In the case of rate hikes, the EUR would likely strengthen more against the USD, JPY and GBP than against the Scandinavian and CE3 currencies," says Wall.

The Euro has struggled against the Pound and Dollar over recent months as investors price in a more aggressive rate hike cycle at both the Bank of England and the U.S. Federal Reserve.

While these two central banks will likely remain ahead of the ECB, at the very least a yawning rate disadvantage that has weighed on the Euro for some time will shrink.

The ECB will likely react to signs of increasing spillover from durables prices into nondurables says Wall. "This is an indicator of greater inflation persistence."

Above: "Underlying inflation continuing to rise quickly" - Deutsche Bank.

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Wall notes too that labour market momentum is strong, boosting his confidence that wage inflation will rise this year and pass into services prices.

Deutsche Bank now expects 25 basis points of deposit rate hikes per quarter from December 2022 until rates reach +0.5% in September 2023, followed by less frequent hikes.

The terminal rate remains at 1.0% but is reached in 2024, two years earlier than previously expected.

"We also consider the ramifications of earlier ECB liftoff for the euro exchange rate," says Wall.

"Our FX strategists still see EUR/USD declining to 1.10 in H1 as any shift in ECB messaging is likely to be backloaded," he says.

But, Deutsche Bank strategists now forecast EUR/USD at 1.15 at end-2022 (from 1.08 previously), and 1.20, 1.25, 1.30 by end-2023, 2024 and 2025.

Deutsche Bank's economists say any delays to a 2022 rate hike could be triggered by a slower rise in wage inflation or a greater tightening of financial conditions because of TLTRO repayments.

The materialisation of geopolitical risk is another potential delay factor; a pertinent observation given the heightened tensions with Russia.

"If ECB lift-off is delayed, the euro will remain significantly weaker," says Wall.