(from our Tactical of 18th October 2016)
One currency that may buck the trend and remain supported against the dollar is the euro. Although tapering from the ECB does not look imminent, core inflation may start surprising to the upside in the eurozone. The chart next shows Economic Sentiment gives a 10-month lead on core CPI, and points to it rising. Furthermore, our CPI diffusion index points to higher headline CPI over the next few months (we expect higher headline CPI as the effects from weaker energy prices continue to wane). Tapering talk is likely to resurface at some point.
On top of this, we have highlighted the structural change in the euro. When the ECB first moved the depo rate negative in 2014, the euro became a funding currency. European banks were recycling the eurozone’s substantial current account surplus, foreigners were hedging inflows and companies from abroad were using low rates to fund in euros. Today, the banks are much weaker and are lending less abroad, hedged inflows are far less significant, and foreigners are raising less money in Europe. As a result, powerful weakening forces for the euro are much less prevalent today.