Macquarie Bank says the euro's rally has a long way to run yet

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Like most other major currencies, the euro has fallen heavily against the US dollar over the past week, undermined by political uncertainty in Germany and renewed optimism that the US Federal Reserve will hike interest rates again before the year is out.

At 1.1745, the EUR/USD is now a fair distance away from the multi-year high of 1.2092 struck earlier this month.

EUR/USD Weekly Chart

The recent pullback has got many questioning whether the euro’s rally this year — seeing it surge 17% from trough to peak — has run its course.

To Matthew Turner, analyst at Macquarie Bank, the answer to that question is no, not by a long shot.

In his opinion, the Euro’s rally is just getting started, forecasting that the EUR/USD will hit 1.3500 by the end of 2019.

That’s a further 15% from its present trading level.

“We now feel there is a risk the dollar unwinds much of the gain seen in 2014-2015, allowing the euro to push higher to $1.25 by end 2018 and $1.35 by end 2019, with a long-term average of $1.30,” he says.

This shows Macquarie’s updated EUR/USD forecasts compared to current market consensus shown in grey.

Source: Macquarie Bank

Turner says that the main factor underpinning this call is that the euro area, like other parts of the world, will see economic conditions continue to improve in the years ahead.

“In our view, the main catalyst for the dollar’s appreciation in 2014 was the pronounced outperformance of the US economy, along with the concomitant policy divergence,” he says.

“But now, while US growth remains stable, the rest of the world is seeing a much better performance, raising the risk that that exchange rates move back toward the levels seen in late 2013.”

Essentially, by playing catch-up to the improvement seen in the US economy in recent years, an improvement in the euro area economy will boost the euro, mirroring what happened with the US dollar between 2014 to 2016.

Although Turner admits that the euro’s move higher “won’t be all plain sailing”, pointing out the persistent threat of political risk and attempts by the ECB to talk down the euro, he thinks this won’t be enough to cap the euro beyond the near-term.

“While we see these issues as keeping a lid on the appreciation in the next few quarters, we think ultimately they will not prevent the realignment as Eurozone growth becomes even more firmly established,” he says.

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