Stronger Euro Could Hurt Rebalancing Process
The appreciation of the euro has been sizeable enough to create concerns about the already-fragile growth outlook for the eurozone in 2013 and 2014. Last week we raised our 2013 average US$/EUR forecast to US$1.34/EUR from US$1.25/EUR previously, and our 2014 projection to US$1.27/EUR from US$1.20/EUR previously. The consistently weakening Japanese yen will also be taking its toll on the international competitiveness of the eurozone, and particularly on Germany, having depreciated against the euro by nearly one-third since the middle of 2012. There are several factors behind these currency movements, but the Japanese government and central bank's concerted efforts to weaken the yen, the Fed's ramping up of asset purchases as of a couple of months ago, and the slowly shrinking ECB balance sheet amid improving sentiment, have all played a part. We have previously highlighted the actions (or lack thereof) of the ECB in supporting a stronger euro ( see o ur online service, February 6, ' ECB Inadvertently Propagating US$/EUR Rally '), but with ECB President Mario Draghi saying last week that the euro move was being monitored, we thought it was worth a look at the potential effects of currency appreciation.
There are several 'rules of thumb' when it comes to the effect of sustained currency appreciation on output. For the eurozone, the general consensus is that for a sustained 10% appreciation in the trade-weighted euro, output falls by around 0.5pp in the first year. The output of our in-house macro model is generally in line with this observation. Obviously this is inexact, not least because it doesn't take into account why the euro is strengthening (it could strengthen under better economic growth in the eurozone, for example). But holding all else constant, the output of the model is fairly consistent with what one would expect: weaker growth, higher imports and weaker exports dragging on the current account balance, and lower inflation. The first chart is of our previous US$/EUR forecasts, and the new ones, with average forecasts straight-lined through each quarter of 2013 and 2014 (rather than using year-end figures). The overall difference is about 7% in 2013 and 5.8% in 2014.
The estimated difference in year-on-year real GDP growth by end-2013 is -0.4pp - and with the euro bloc as a whole flatlining (our 2013 growth forecast is 0.1%), that difference could be significant. The rebound in 2014 mainly reflects the base effects of a very weak 2013; the overall level of real output is around 0.3 -0.4 pp lower by the end of 201 3 and a bit less than that by the end of 2014 , which is around what the 'rule of thumb' of FX appreciation would posit. In this context, our 0.1% real GDP growth forecast for 2013 for the eurozone as a whole may be in line for a slight downgrade. This would particularly be the case if the euro strengthens to US$1.40-1.45/EUR for a sustained period (though we believe at this stage that such appreciation would be only fleeting).
|US$/EUR Exchange Rate Forecasts, Average|