Interest rate expectations support Euro according to Bank of Ireland
Market priced for series of ECB moves
Expected timing of US rate rise may move forward
The euro had a strong first quarter, appreciating against all the major currencies and effectively reversing the fall seen over the final three months of last year. From an Irish perspective, the most significant moves were against the US dollar and sterling; the single currency has rallied from under $1.30 to over $1.42 against the former and from 83 pence to 88 pence against the latter, according to Bank of Ireland’s latest Bulletin which was published today, 6 April 2011.
Author of the Bulletin, Dr. Dan McLaughlin, Group Chief Economist, Bank of Ireland said:“The euro’s decline in late 2010 was attributed to investor concerns about the risks of default on sovereign and bank debt within the euro area, and those concerns are still evident; 10-year yields on Greek debt are still over 12%, the Irish equivalent has moved to around 9.5% and the market is now focussed on Portugal, with yields now above 8%. The EU has agreed to boost the spending power of the main existing support mechanism, the EFSF, but the additional funding required is not yet forthcoming, and is unlikely to be sorted until mid-year, so there are still some issues to be resolved.
“Yet the euro has risen despite these headwinds, and that appreciation is due to two factors. The first is the interest rate outlook – the ECB has signalled that it is likely to raise rates soon, probably this month, and the market is now expecting a series of rate increases over the next year. In contrast, the market does not expect the US to raise interest rates until March 2012, and this divergence in expectation is very supportive of the euro; an investor buying a 2-year German bond receives 1.8% per annum, against just 0.8% in the US. Similarly, the interest rate differential relative to sterling is also positive, at 0.5%. Secondly, market positioning has switched sharply in recent months – traders sold the euro aggressively till mid-January, but have now built up substantial long positions in the euro and have sold dollars, and this has also supported the single currency.
“The implication is that a rally in the dollar against the euro is unlikely unless US interest rate expectations change, and these in turn are most likely to be affected by the trend in US employment – the pick-up in the pace of job creation may well prompt the market to bring forward the expected timing of a US rate rise. We suspect this will indeed occur, and as such expect a near-term pull-back for the euro/dollar rate”, concluded Dr. Dan McLaughlin.
6 April 2011
Dr. Dan McLaughlin Anne Mathews
Group Chief Economist Media Relations Manager
Bank of Ireland Global Markets Group Communications
Tel: 01 609 3221 Bank of Ireland
Tel: 076 623 4771 / 087 246 0358