EUR/USD Exchange Rate to Rally in 2016 According to Lloyds Forecas

Lloyds Bank maintain expectations for near-term euro weakness as prospects of policy tightening in the United States come into sharper focus.

However, picking the bottom in the EUR-USD exchange rate will be key as the bank predicts the euro will start a gradual recovery in early 2016 as the Eurozone economy starts to improve courtesy of the ECB's ongoing massive moneteray stimulus.

EUR/USD has been dominated over the past month by the tumultuous events in Greece and, to a lesser extent, guesses over when the US Federal Reserve will begin raising interest rates.

These two issues have ensured the euro to dollar exchange rate conversion has oscillated around 1.11, with downside pressure on the euro from the Greek crisis broadly offset by downside pressure on the US dollar from a scaling back in US interest rate expectations.

More recently the single currency has broken lower moving below 1.10, but has found buying interest to be strong at 1.08.

The recovery off this support zone has seen us watching for a fresh break above the 1.10 area in the near-term.

Lloyds say the drop has occurred amid (i) scepticism over whether a Greek deal can be finalised; (ii) renewed speculation of a possible rise in US interest rates this year; and (iii) the euro’s status as a funding currency (investors have naturally sought to borrow cheap euros to purchase foreign currency assets).

These considerations should ultimately dictate the exchange rate’s outlook.

Euro Forecasts Downgraded Near-Term

The 1.08-1.10 range could well be a precursor to further declines according to analysts at Lloyds who are forecasting the euro exchange rate complex to fall lower from here:

Although Grexit fears have subsided for now, implementation risks and debt sustainability concerns should keep the euro under pressure.

“We have revised lower our €/$ forecast for September to 1.03 from 1.05, but have maintained the year-end target of 1.07, helped by the possibility of Greek debt relief,” say Lloyds.

Analysts have also revised higher their £/€ forecast for end-2015 to 1.46 from 1.44. £/$ is seen weaker at 1.53 by September, but rising to 1.56 by year-end.

For now, however, ongoing event risk in Greece, the probability of a US rate rise in H2 and the ECB’s QE are projected to push the euro lower.

A drop to 1.03 is targeted by end Q3.     

Looking ahead, a resolution to the Greek crisis coupled with a steady recovery in euro area economy should see EUR/USD move higher over the longer term.

The July PMI's confirm the trend for a slow but steady recover in the Eurozone - while the July figures came in below expectations they do confirm a broader trend of a recovering eurozone.

ECB President Draghi remained relatively upbeat about euro area economic growth and inflation prospects, but warned that the ECB would act if there is an unwarranted tightening of monetary conditions.

He reiterated that the return of inflation to target would require a “full implementation” of the QE programme through September 2016.

As such markets are expecting German interest rate yields to rise with the 10-year bund yield at 1.0% by the year-end.

Should Eurozone bond yields close the gap on US and UK yields then we will start to see the euro dollar and euro pound exchange rates start to rise once more.