The Tell: The euro could rally to $1.30 within 12 months, says currency strategist

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The euro may make a charge at $1.30 over the next 12 months, aided by a depreciating U.S. dollar, strong buying support from other central banks and an anticipated change in European Central Bank’s policy posture, finally kicking off its policy normalization after years of ultralow interest rates.

That’s according to Stephen Gallo, European head of FX strategy at BMO Capital Markets, in a recent research note.

“We look for a summer rebound in the euro-dollar pair to $1.21 as the ECB lays the groundwork for a late-2018 quantitative easing reduction,” the BMO strategist said, betting that in 12-months, the pair EURUSD, +0.3517%  would rise to $1.30. The euro last bought $1.1983 on Monday.

Over the near term, the U.S. dollar DXY, -0.21% has had a buoyant April and reached a four-month high in early May before edging lower again this week, leading investors to wonder whether it hit its ceiling.

However, Gallo sees the euro in prime position to head higher, making the case that the currency bloc’s central bank has lagged behind other developed-world central banks in terms of monetary-policy normalization.

Gallo sees the buck mostly retreating from its current perch, the euro being bolstered by central bank buying amid steps by Mario Draghi’s European Central Bank to gradually taper its asset-buying program, with an eye toward joining the Federal Reserve in tightening monetary policy.

Market participants anticipate that Draghi will announce that quantitative easing and the end the easy-money era some time this summer. Officially, the central bank will continue to purchase assets until September.

Most analysts don’t forecast any interest-rate hikes until well in to next year. However, of late, ECB officials have been stressing the importance of economic data, which recently slowed in the first three months of the year.

Euro bulls have clung to the narrative that this recent spate of dollar strength will be short lived, and are betting that as soon as the ECB takes a hawkish stance, the euro will rally.

So far, the ECB’s go-slow approach, has been a contributing factor in pushing the dollar higher and the euro lower earlier in 2018, in recent trade, with currency traders attracted to the higher rates in the U.S. making dollar-assets more attractive as interest rates climbed on the back of increasing fears of runaway inflation.

Those fears had mostly subsided, even as crude-oil prices CLM8, +0.42% rallied in recent weeks to the highest levels since 2014, on the back of the U.S.’s withdrawal from the Iran nuclear deal that will see sanctions slapped back on the oil-exporting Middle Eastern nation.

However, crude-oil’s renaissance—if it holds—may be sufficient to drive inflation back to a place that might prompt the ECB to action, Gallo argues.

“Given structural factors, there is little that the ECB can do to push underlying inflation higher but higher oil prices may do the job,” Gallo suggested. Preliminary data for April had consumer-price inflation at 1.2% on the year and 0.7% for the core figure that strips volatile components out. The ECB’s target is just below 2%.

The ECB is next due to meet on June 14.

See: Commodity currencies rally amid renaissance for oil

To be sure, there are also downside risks to this euro optimism.

Gallo says that due to a dearth of European bonds, amid the ECB’s QE bond-buying binge, that eurozone debt rates might be held in check, in turn, capping moves for the euro, because currency investors tend to buy currencies in regions that offer rich yields.

The eurozone also lacked an “adequate supply of liquid, safe haven assets. In the context of stubbornly low inflation, demand for euro-denominated sovereign bonds will continue to put a lid on euro rates,” Gallo said.

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