Euro Exchange Rate Forecasts (And Why You Shouldn't Care)

Although the stock market rally has continued on both sides of the Atlantic, if you have had investments in the Eurozone you have probably lost considerable amounts of money in the recent months due to unfavourable currency developments.

Although it’s hard to believe when looking at the current exchange rates, the euro traded almost at 1.40 against the dollar in May last year. Since then it has been only one way, with just minor corrections. Trading below 1.06 at the time of writing this article, the euro has lost almost a quarter of its value in less than 12 months. Against the pound the losses have been smaller, but still over 12% in the same period.

Euro/Dollar Forecasts by Major Banks
The questions many investors ask are how low the euro will go and when it will recover? Big financial institutions and their analysts are, as usual, ready to provide the answers.

Unfortunately, their views are diverse. Goldman Sachs and Deutsche Bank are among the greatest pessimists, predicting EUR/USD parity (1.00) later this year and 0.80 (Goldman) / 0.85 (Deutsche) by 2017. On the other end of the spectrum there is HSBC with 1.20 by 2017, but they still expect the euro to remain weak for the rest of this year. The other big banks place their forecasts somewhere between these two extremes, mostly predicting continued euro weakness. None of the major banks are expecting the euro to make a significant rebound and go back to the 1.30’s any time soon.

Reasons for Weaker Euro
Forecasts of further euro losses (against both the dollar and the pound) are primarily based on monetary policy. The markets’ consensus at the moment is for the US Fed and the Bank of England to start tightening monetary policy and hiking interest rates earlier than the European Central Bank, as the European economy seems to be in a much worse shape than the US and the UK. There is the unresolved issue of Greece, but many other and more important countries, including Spain, France and even Germany in some ways, have shown signs of economic weakness. Long-term structural issues, such as unemployment, overstretched social security systems, immigration and low confidence in European institutions can also contribute to further pessimism.

Reasons for Stronger Euro
While the above mentioned problems are widely acknowledged, some analysts point out that recent losses in the euro exchange rate have been too big and the euro is undervalued against both the dollar and the pound. Moreover, dollar and pound interest rates may remain at their current low levels for longer than expected and any increase will almost certainly be very gradual and careful, limiting the interest rate differential and the resulting pressure on the euro.

Analysts Have Been Consistently Wrong
If you remember summer 2008, just weeks before the Lehman bankruptcy when the euro was briefly trading above 1.60 against the dollar, you may also remember the analyst forecasts from that time. Many were expecting the euro to continue rising, with figures like 1.80 and even 2.00 not uncommon. Some were saying the euro would replace the dollar as the world’s reserve currency. The euro actually lost 23% in less than four months and traded below 1.24 later that year.

Just four years ago, in May 2011, the same Goldman Sachs that is now predicting 0.80 had predicted EUR/USD to reach 1.55 in 12 months. It didn’t and instead it ended up below 1.24 in May 2012.

This does not mean that Goldman or the other banks have bad analysts – they have some of the best. It means that the world’s currency markets are impossible to predict and any forecast must be taken with a grain of salt.

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