The euro slipped on Friday but its uptrend of the past three months still looks intact, with the prospect of more interest rate rises from the European central bank seen offsetting concerns about the ability of some poorer euro zone countries to pay their debts.
The euro is up nearly 8.0 percent against the US dollar and 10.4 percent versus the yen in 2011, helped by interest rate differentials with the short end of the euro zone yield curve significantly above the US yield curve.
-- Euro slips but seen rising to $1.50
-- Central bank policy seen favouring euro
-- Debt ceiling debate seen weighing on US dollar
Inflation accelerated in Europe and Asia in March while the United States bucked the global trend with underlying price pressures largely in check, leaving monetary policy set by the ECB and the Federal Reserve diverging paths.
"You have two central banks with two different monetary policy stances, with the euro the clear winner in this interest rate game," said Bruce McCain, senior vice president and chief investment strategist at Key Private Bank in Cleveland, Ohio.
"The concern is rising oil and commodity prices and I fear that consumers will get spooked enough to dramatically lower spending, which will make US economic growth even weaker." That could push Federal Reserve interest rate rises even further down the road, he said. "We are bearish on Treasuries and prefer to maintain a minimal position," McCain said.
The ECB raised its benchmark interest rate to 1.25 percent from 1.0 percent last week, its first rate hike since July 2008, but many economists believe the Fed will not raise rates until early in 2012. Investors are pricing in the chances of two more ECB rate increases before the end of this year. In late afternoon New York trading, the euro was down 0.4 percent at $1.4432, off a 15-month high of $1.4521 touched earlier this week. The euro was down about 0.3 percent this week.
However, Deutsche Bank said the euro looks capable of extending its gains to near $1.50, or 30 percent above purchasing power parity (PPP). History shows that an overvaluation of 30 percent would give a clear bearish euro signal for the subsequent 12 months and typically, the euro corrects by 10 percent once a 30 percent overvaluation is reached, the bank said.
"With the first quarter behind us, it is now evident the clearest trend has been euro strength; not only did it go up almost continuously, the euro outperformed all other G10 currencies." "The near-term picture remains fairly positive for the euro. But the strength of performance alone suggests that the euro will struggle to outperform over the next quarters, while medium-term drivers suggest it is too late to jump on to the uptrend," the bank said.
The US dollar slipped 0.5 percent against the yen though on Friday to around 83.12 yen. The yen has risen in six of the last seven sessions and was on track for best weekly performance against the dollar in about nine months with gains this week of 2.1 percent.
US DOLLAR STILL VULNERABLE The US dollar, meanwhile, remains vulnerable to the risk that the US Congress may not raise the limit on the government's debt ceiling before the limit is hit around May 16. "The USD dodged the 2011 budget bullet last weekend and is now facing the debt ceiling cannonball," said Steven Englander, head of G10 strategy at CitiFX in New York.
The US Congress on Thursday approved a budget deal to avert a government shutdown, but mass defections in both parties highlighted the difficult fights ahead on spending and debt reduction. Foreign exchange markets are increasing the attention they pay to fiscal sustainability relative to monetary policy, Englander said.
"The USD will be in big trouble if investors get the sense that the debt ceiling negotiations have gone beyond the expected choreography into a zone where there is perceived risk to US credit." "The FX response may be non-linear so G10 countries may have a false sense of security in seeing little FX response to deterioration so far," he said.