More Euro Gains And Yen Suffering

Despite the strong euro gains seen over the past six weeks, we maintain our view that among the four major currencies, the euro will still be the top pick in H1 13. The combination of (i) fewer tail risks attached to the single currency, (ii) the ECB rejecting calls for further easing of monetary policy and higher EONIA rates due to repayment of the LTRO money and (iii) a general strong risk sentiment are all factors pointing to further euro performance. The euro is forecast to peak on a 6M horizon reaching 1.38 (1.36) against the US dollar. On a 12M horizon, focus will turn to the Fed and when it will exit its QE programme. The 'exit' will be dollar supportive and at the same time the support to risk currencies including the euro from the global recovery should be exhausted. We forecast EUR/USD at 1.34 (1.32) on a 12M horizon.

We continue to see USD/JPY and EUR/JPY moving higher over the next six months as a new BoJ governor is sworn in. We have pencilled in that USD/JPY will hit 100 (96) on a 12M horizon. The Japanese economy is still forecast to look weak at end-2013, which is likely to prompt new easing measures from the BoJ at a time when the Fed is in 'exit mode.' We expect sterling to continue to appreciate despite the incoming BoE governor Carney setting the 'bar for changing the flexible inflation targeting framework high.' We expect Carney to commit to keeping rates low for a prolonged period and to accept high inflation for an extended period of time. Combined with safe-haven flows returning to the eurozone, we expect EUR/GBP to rise towards 0.90 (0.85) on a 6M horizon.

The moves in the FX market over the past three months have been quite significant and global central bankers are alert. Even though we hold the view that there is no such thing as a currency war and that monetary policies in the UK, Japan and the US are oriented towards domestic objectives (stable inflation and output growth), there is no doubt that the ECB - not least since Draghi has been in charge - has become much more pragmatic. Hence, if the euro gains accelerate and it jeopardises the inflation target, the ECB will act. If EUR/USD moves significantly over 1.40 and growth falters, an ECB rate cut is likely in our view. Hence, significant swings in EUR crosses and rising volatility should not be ruled out in 2013.

We still see value in Scandies, with the SEK potential, in particular, strong. The Riksbank is now on hold and as one of the few G10 central banks Governor Ingves is not concerned about the value of his currency. We see EUR/SEK falling to 8.20 (840) in 2013. EUR/NOK is also expected to drift lower. However, Norges Bank is more vigilant on the currency and the NOK potential is more limited.

Since new year, AUD has moved consistently lower, CAD occasionally so, whereas NZD has stageda noteworthy comeback. While this is due partly to changes in central bank rhetoric, we still see limited upside in the commodity currencies despite the cyclical rebound in H1 13, as the euro rebound means that the safe-haven flows supporting these 'new' safe havens has now reversed.

We have revised our Czech koruna forecast in a less negative direction. The CNB did not decide to intervene in the FX market to weaken the koruna as we had expected. Our new EUR/CZK forecast is 26.0, 26.2 and 26.0 in three, six and 12 months respectively. It is based on the view that the CNB will sharpen its FX rhetoric once again.

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