Feb Update: Euro Dollar Exchange Rate Forecasts for 2014: EUR/USD Outlook Suggests Risks Lie to the Upside

The euro dollar exchange rate (EUR/USD) forecast for 2014 at Danske Bank has been tweaked in January allowing for a less bearish viewpoint on the euro in the near term. The February FX forecast has added to this theme with the bank saying the risk to their view is to the upside.

Danske Bank have issued a foreign exchange rate forecast update which follows the broader market theme for a weakening euro and appreciating US dollar in 2014.

However, this is not the full story; analysts have warned that they are upping their near-term euro forecasts as they predict the European Central Bank (ECB) will not readily jump into a round of fresh easing. It is the divergence in central bank policy that will be key for currency movements in 2014 say Danske.

For reference, the spot euro dollar exchange rate (EUR/USD) is quoted at 1.3717 in the London afternoon session on the 20/02/2014.

Below are quotations from the foreign exchange rate forecast note penned by Christin Tuxen, Senior Analyst at Danske Bank:

February Update: Risks are to the upside

February sees Danske retain their bearish stance towards the EUR. However, as was the case in January, the extent of the likely EUR weakness has been curtailed:

"Longer term, our call for a softer EUR/USD remains driven by our view that the Fed intends to end tapering this year but the USD part of the story will be a prolonged and gradual process. Also, we stress that recent weakness in US data hints at the risk of a tapering pause later this spring which together with a lack of ECB reaction could reduce EUR/USD downside potential markedly. Nevertheless, we now see EUR/USD at 1.35 in 1M and have kept our profile unchanged, thus still seeing the cross at 1.26 in 12M – albeit we stress, however, that risks are increasingly on the upside."

Near-term euro forecasts upgraded

We have upped our near-term EUR/USD outlook a little. Strong peripherals performance and the outlook for less imminent easing from the ECB make the case for EUR downside less strong on a 3M horizon. Also, the weather-related uncertainty regarding US data and hence whether Fed tapering will continue unabated limits USD upside a little in the months ahead.

US economy losing steam

Economic data has lost some steam in the US recently, whereas eurozone data has surprised on the upside. We expect the US to grow decisively this year but see more potential for positive euro-zone surprises.

The euro dollar forecasts in numbers

We now see EUR/USD at 1.33 in 3M but have kept our 6M and 12M forecasts unchanged at 1.30 and 1.26, respectively. We stress though that if we are wrong in projecting downside inflation surprises, the 3M outlook for EUR/USD is likely to be at least a few big figures higher as eurozone activity is on course for a strong start to 2014.

Outlook for the euro dollar will depend on monetary policy

Relative monetary policy is set to become a key source of EUR/USD downside in the medium term. In the absence of negative data surprises, the Fed tapering is on course with USD10bn per meeting. The ECB is keeping its options open and a deposit rate cut in response to lower-than-expected inflation is set to underline monetary-policy divergence.

Both ECB and US Fed must take action in 2014

While improving in both regions, the relative growth outlook is set to support the Fed moving away from extremely accommodative policy measures long before the ECB. This should set the scene for a cyclical USD uptrend, as the Fed will be looking to hike rates way ahead of its eurozone counterpart. However, we stress that our outlook for a weaker EUR/USD in 2014 requires both the Fed and the ECB to take action: we still think there is potential for a steeper US money-market curve to push USD higher as the Fed ends tapering later in the year, and for the ECB to convince markets of its determination to anchor the short end of the EUR curve.

Euro to benefit from investment inflows

The eurozone current account surplus continues to rise, while the US is stuck with a deficit. The combination of the ECB’s OMT programme and the eurozone escaping recession should help attract capital again and support the EUR, ceteris paribus.

What is current fair valuation of the euro?

EUR/USD is not far from its PPP level. Also, our short-term models suggest that the fair value for the cross is around 1.36 currently.