6-12 Month Foreign Exchange Forecasts: Danske Bank End-June 2022

• 2022-2023 exchange rate forecasts from investment Danske Bank – update June 2022
• Inflation pressures will be persistent and force further central bank rate hikes further.
• Fed rate hikes and tighter financial conditions will support the dollar.
• EUR/USD forecast to weaken to parity in 12 months.
• Japan will eventually resist further yen weakness, USD/JPY strength to fade
• Sterling unlikely to make headway much as BoE rate hikes lag market expectations.
• GBP/USD forecast to trade around 1.20 during the next 12 months.
• Tighter financial conditions will undermine commodity currencies.

Tighter Financial Conditions give the Dollar Crucial Advantage

Danske Bank notes that central bank rhetoric and actions have turned much more hawkish over the past month with some notable reversals of positions.

The Federal Reserve, for example, increased interest rates by 75 basis points to 1.75% in June after stating at the previous meeting in May that such a hike was not under consideration.

The ECB has committed itself to a July rate hike and the Swiss National Bank increased rates last week.

Danske considers that central banks have been forced to respond as the narrative of transitory inflation has collapsed.

It also expects that inflation pressures will continue due to underlying global imbalances. It adds; “Demand is simply too high relative to global production capabilities and central banks no longer have the luxury of easing policy amid the risk of de-anchoring inflation expectations.”

Danske expects that both the Federal Reserve and ECB will have to tighten monetary policy further; “In both economies, inflation is running hot and central banks are leaning against this.”

There are two important stands to the Danske case for exchange rate moves; the US economy will out-perform and that financial conditions will tighten further.”

The bank still expects that the US economy will out-perform over the next year due to important advantages; “US stands out as a relative winner, given large sectors in energy, agriculture and defense.”

It also expects that the tighter financial conditions which will have important implications for exchange rates with the US dollar likely to benefit on both factors.

Danske also expects that high energy prices will continue to sap support for the Euro-zone economy.

In this context it adds; “The large negative terms-of-trade shock to Europe vs US, a further cyclical weakening among trading partners, the coordinated tightening of global financial conditions, broadening USD strength and downside risk to the euro area makes us keep our focus on EUR/USD moving still lower.”

It maintains a 12-month Euro to Dollar (EUR/USD) exchange rate of 1.00. It is, however, worth noting that Danske forecasts imply very narrow ranges for major currencies which looks to be unlikely given overall conditions.

Yen Selling will Reach a Peak

The Bank of Japan remains committed to a very expansionary monetary policy while high energy prices will also tend to undermine yen support.

According to Danske; “Upside risks to USD/JPY comes from a continued high pressure on commodities driving inflation and global yields higher.”

It does, however, note that concerns over the impact of inflation within Japan will intensify, increasing the risk that there will be a move to stem yen losses.

It notes; “There is a cap on USD/JPY somewhere, though, and if Tokyo decides to intervene, it will probably have a large impact, at least in the short run. Japan has the world’s second largest currency reserves, and thus also has the muscle to provide strong support.”

Swiss franc Forecasts Raised

Danske expects that the Swiss National Bank will continue to tighten monetary policy with benchmark rates increasing by a further 100 basis points to 0.75% at the end of 2022.

It expects that overall yield spreads should have a limited impact given that the ECB will also tighten monetary policy.

The tighter global financial conditions will be important with the Euro to Franc (EUR/CHF) exchange rate remaining under pressure.

It added; “We continue to forecast the cross to move lower on the back of fundamentals and tighter a global investment environment characterised by tighter economic policy and global liquidity conditions.”

The dollar to franc (USD/CHF) exchange rate is forecast to trade below parity during the forecast period.

No Enthusiasm for Sterling

Danske expects that further Bank of England (BoE) rate hikes will not meet market expectations, although there is an important element of uncertainty; “ we expect two additional 25bp rate hikes this year, fewer than what markets are pricing in, although risks are definitely skewed to faster tightening.”

If global central banks hikes rates faster than the BoE, Sterling will be vulnerable.

Danske also expects that tighter global risk conditions will also pose important risks to the UK currency.

“The UK runs a large current-account deficit, which makes the GBP vulnerable when capital flows fade.”

Overall, Danske expects little overall Sterling change and, although it has held the Euro to Pound (EUR/GBP) exchange rate forecast at 0.84 for 12 months, it notes short-term upside risks.

Tighter Financial Conditions to sap Commodity Currencies Backing

Danske expects that global commodity prices will remain firm due to supply concerns.

Commodity currencies will gain some support from elevated prices, but the bank expects that this will be offset by tighter global financial conditions.

Overall forecasts for commodity currencies have been downgraded with all losing ground against the US dollar on a 12-month view.

For the Australian dollar it notes; “downside risks include slowdown in global economic growth and further Covid-challenges in China, and all together, we maintain our forecast for lower AUD/USD throughout the horizon.”

Danske expects similar pressures on the Norwegian and Swedish currencies with interest rate hikes having only limited impact given global monetary tightening and weaker risk conditions.

For the Norwegian krone, it notes; “In the current environment of weakening growth prospects and central banks still tightening financial conditions, NOK remains vulnerable.”

Table of currency forecasts from Danske Bank covering period 2022-2023.