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EUR/USD to Grind Higher in 2018, Say BMO Capital Markets, as Bullish Forecasts Pile Up

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Euro to take two steps higher once the Italian elections are out of the way and the European Central Bank (ECB) unwinds its currency-debilitating stimulus programme.

The Euro will rise steadily in 2018, according to the latest forecasts from investment bank BMO Capital Markets in Toronto, Canada.

Its initial push higher will come once the Spring general election in Italy returns a moderate government in favour of retaining the Euro. This will eliminate the political risk that may weigh on the currency early next year.

Italy, therefore, does "not pose an existential threat to the Eurozone in 2018," says Stephen Gallo, BMO's European Head of FX Strategy.

The second boost will come in March from the European Central Bank once it announces another reduction to its stimulus, or quantitative easing (QE), program.

It has already said that in January it will to reduce its bond buying (QE) - otherwise known as “asset purchase programme” - from €60bn per month to €30bn.

QE was brought in as an emergency measure to support the Eurozone economy, which had seen economic weakness drive inflation substantially below its 2% target.

Such stimulus is generally detrimental to the Euro because it keeps interest rates low, in order to spur economic activity and thus inflation, which are all major drivers of currency appreciation.

Higher interest rates attract greater inflows of foreign capital, that is in search of higher returns, a by-product of which is increased demand for the currency.

The second boost for the single currency will come in the summer when the ECB is expected to decide when it will be end the QE programme completely, although it will also benefit from a continuation of the current economic recovery.

These factors could easily lead markets to begin looking for a rise in European interest rates once again.

"Once Italian election risks are cleared, we expect two confirmation rallies in the EUR as the ECB announces a QE taper in March and alters its forward guidance on rates in June," says Gallo.

The idea of two discrete jumps in the Euro as a result of the ECB normalizing its policy is similar to forecasts made by Petr Krpata, Chief EMEA FX and Interest Rate Strategist at ING Group.

"As the key Euro driver, we continue to focus on the European Central Bank's (ECB) two-step exit from its current ultra-loose unorthodox policy stance, translating into two discrete jumps in EUR/USD higher."

Krpata says an end to QE has not yet been completely priced into the exchange rate, despite it being widely advertised. This is a big factor behind Krpata and the ING teams forecast for the Euro to reach 1.30 against the Dollar in 2018, which is bullish even by bullish standards. BMO is more cautious in its outlook.

"BMO FX Strategy looks for EURUSD to trade at 1.21 in 3M, 1.22 in 6M and 1.25 in 12M," Gallo writes, in the bank’s year ahead outlook.

Meanwhile, BMO forecasts the Dollar will see protracted but steady decline during 2018, based on the twin factors of global growth acceleration ('rest of the world' catching up) and diminishing upside from Federal Reserve rate hikes.

See our US Dollar coverage for more information.

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