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Since the end of March, the euro has appreciated by about 4% against the dollar, and at ~1.22 the EUR/USD pair is now back roughly where it started the year. Despite its recent resurgence, economists at Capital Economics continue to think that the euro will weaken against the dollar this year.

See:  EUR/USD to hit the 1.25 mark by September – Deutsche Bank

Reassessment of the economic outlook and monetary policy in the eurozone and the US

“Our view remains that the ECB will keep policy settings very accommodative for several years. Money markets now discount ECB rate hikes starting in the first half of 2023 – far earlier than we think is likely. Underlying growth and inflation dynamics are much weaker in Europe than the US, and we do not expect the ECB to meet its inflation target on a sustained basis or to raise rates until much later this decade.”

“In the near-term, it is also unlikely that the ECB will welcome continued upward pressure on the euro or on long-term eurozone bond yields. In particular, the rise in the spreads between the yields of German and ‘periphery’ sovereign bonds over recent weeks may prompt at least some pushback from policymakers.”

“We also think the Fed will raise rates a bit later than currently discounted in money markets, the difference is much smaller – we expect the first hike in the second half of 2023, roughly two quarters later than what is currently discounted. More importantly, we forecast that the US economy will return to its pre-pandemic trend this year, while we don’t expect the eurozone to do so for a long time. We also think that underlying inflation pressure in the US is much stronger and durable than in Europe and that US core inflation will remain above 2% even after the transitory effects related to the pandemic fade. As a result, we expect US long-term bond yields to resume their rise before long.”

“We are sticking to our forecast for EUR/USD to end the year at 1.15. In our view, the combination of economic outperformance in the US, stronger underlying price pressures there, and the relative pace of Fed and ECB policy normalisation all point to a stronger greenback.”

 

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