ECB in no hurry to hike interest rates
The European Central Bank (ECB) surprised the market at its June meeting. No real news was expected to emerge from the meeting but the ECB had a different view. First, the central bank announced that QE would be further tapered in Q4 18 to EUR15bn per month and cease completely by the end of the year. Second, it signalled that interest rates would not be raised until after summer 2019, at the earliest. The bond announcement had been generally expected by the market but it was surprising that the announcement was made so early. The announcement on rates was another surprise, which explains why market reaction was generally positive and why EUR/USD declined. The ECB's message was clear: it is in no hurry to hike rates. This sits well with our expectation that the first rate hike will not materialise until December 2019.
Calm returns to Italy
The political situation in Italy drew considerable attention in late May/early June, leading to turmoil in the financial markets. However, calm has returned as the likelihood of fresh elections and fears over Italy's euro membership have faded. Italian yields have remained high, and political discord between Italy and the EU may well flare up again if Italy insists on increasing its budget deficit above the EU limit of 3% of GDP.
Fed hikes interest rates again
The US central bank (Fed) raised interest rates for the second time this year at its meeting in June. The Fed also signalled a possibility of another two rate hikes this year. We share the Fed's view, so we have adjusted our forecast to include two more rate hikes in 2018 - probably in September and December. We still expect interest rates to be raised three times next year.
The dovish ECB - combined with a US central bank still on course for higher interest rates - has produced a tailwind for the USD of late. Meanwhile, the turmoil around Italy has done nothing to support demand for the EUR. In the short term, we expect EUR/USD to hover in the 1.15-1.21 range. However, looking 12 months ahead, we still expect EUR/USD to increase to 1.25.
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