Top forecaster sees weaker euro on ECB embracing QE

One German bank rode the euro’s weakness to become the world’s most-accurate foreign-exchange forecaster, and it sees no reason to give up on that view even with the currency near its weakest level in two years.

Landesbank Baden-Wuerttemberg, which topped Bloomberg’s rankings for the four quarters ended Sept. 30, is predicting the euro will tumble more than 4 percent to $1.20 by the end of 2015, adding to its 10 percent drop from this year’s high of $1.3993 in May. Its forecast is more bearish than the consensus, which is for a decline to $1.23, based on the median estimate of 48 strategists in a Bloomberg survey.

What makes Stuttgart-based LBBW so bearish is its belief that the euro-region economy is in such a perilous state that the European Central Bank may have no choice but to embrace U.S.-style quantitative easing measures as soon as next month. Such a policy, which entails buying government bonds and expanding the money supply, tends to devalue a currency.

“We still haven’t seen the maximum power of ECB easing,” Julian Trahorsch, who’s part of the team responsible for LBBW’s currency estimates, said by phone on Oct. 2. “The ECB has a bigger arsenal than many other central banks.”

Balance Sheet

ECB President Mario Draghi fleshed out details of his latest stimulus plan to weaken the euro and boost inflation after the Oct. 2 policy meeting in Naples, Italy. He said he wants to “steer” the central bank’s assets toward early-2012 levels, when they were at more than 3 trillion euros ($3.8 trillion), compared with about 2 trillion euros now.

The plan includes buying asset-backed bonds such as mortgage securities. While Draghi stopped short of committing to government-bond purchases, the euro plunged the next day to $1.2501, its lowest level since August 2012.

The shared currency rose 0.3 percent to $1.2548 at 6:11 a.m. New York time today.

LBBW, the largest German state-owned lender, topped the overall rankings for a second straight quarter. The best forecasters in Bloomberg’s rankings were identified by averaging individual scores on margin of error, timing and directional accuracy across 13 currency pairs during the past four quarters. Banks had to be ranked in at least eight of the 13 pairs to qualify for the overall placing, with 56 making the grade.

BNP Bear

The score of 64.33 registered by LBBW topped ING Groep NV, which came in No. 2 at 61.02. Westpac Banking Corp. was third with a score of 59.93, followed by Rand Merchant Bank at 59.55 and Mouvement Desjardins at 58.42.

France’s BNP Paribas SA, first in Bloomberg’s rankings for euro-dollar predictions, is more bearish on the 18-nation currency than LBBW. It forecasts a drop to $1.18 and expects the ECB to introduce QE early next year.

“The ECB needs to do a lot more liquidity injections,” Steven Saywell, the London-based global head of foreign-exchange strategy at France’s biggest bank, said by phone Oct. 2. “It’ll do enough eventually, but it’ll do it quite late. And it will only do it because it has to do it.”

A weaker euro suits Draghi because it makes exports more competitive. It also helps stoke inflation which, at an annual rate of 0.3 percent in September, was the slowest in five years and a fraction of the ECB’s target of just under 2 percent.

With the U.S. recovery gaining pace and speculation the Federal Reserve will raise its main interest rate from the zero- to-0.25-percent range it’s been in since December 2008, the dollar is surging. That’s putting additional pressure on the euro.

Diverging Policies

The dollar strengthened 7.4 percent in the past three months versus a basket of nine developed-nation peers tracked by Bloomberg Correlation-Weighted Indexes. That’s the best performance in the group. The euro, which fell 1.8 percent, is the biggest loser after the New Zealand dollar’s 5.7 percent drop.

The divergence between Fed and ECB policies will push the euro down to $1.18 by the end of 2015, according to ING.

Because domestic demand is a major driver of U.S. growth, it’ll be a long time before the Fed says “enough is enough,” and seeks to halt the greenback’s appreciation, Chris Turner, ING’s London-based head of currency strategy, said in an Oct. 2 phone interview.

‘Priced In’

Westpac is less confident the euro will keep falling, and says the yen will decline in coming months. The Australian bank predicts the euro will climb more than 4 percent to $1.31 by mid-2015 as the yen drops to 112 per dollar, from 109.32 today.

“Draghi is priced in,” Huw McKay, a senior international economist at Westpac in Sydney, said by phone on Oct. 2. “That’s why we’re not extending the move in euro much further than where we presently are.”

Germany’s Bundesbank has led opposition to expanding the ECB’s bond purchases to government debt, saying it risks sparking too much inflation and may remove incentives for poorer euro members to improve their finances. Goldman Sachs Group Inc. says there’s a 30 percent chance of full QE by mid-2015.

A policy split within Europe will drive sterling higher, according to Intesa Sanpaolo SpA, the No. 1 forecaster for the pound versus the euro.

Asmara Jamaleh, a Milan-based economist at the bank, sees Britain’s currency strengthening over 4 percent to 75 pence per euro in the next three months. If the Bank of England raises rates before the Fed, sterling may reach $1.70 in six months, she said. The pound traded at $1.5989 today.

“The performance of the U.K. economy is much better than the euro zone,” Jamaleh said by phone Oct. 3. “The BOE is going to raise interest rates in the first, or at the latest in the second quarter of next year.”

[Bloomberg]