Goldman Sachs has revised its forecast on the EUR/USD exchange rate, predicting a “milder” downside to the eurozone currency because of expectations of further rate hikes by the European Central Bank.
The New York-based multinational bank maintains that the EUR/USD rate would breach the 1.10 level by the year’s end, two percent above the current rate. However, Goldman Sachs analysts predict that the downside of the EUR/USD would be closer to the 100-hour moving average of 1.09238. The bank also expects an extended recovery period for the currency pair after a significant drop in May.
Last month, Goldman Sachs published a note that indicated a “weakness” in the euro’s performance against the greenback. After hitting 1.1095 in April, the euro fell to 1.0760 against the dollar in late May. Analysts at Goldman Sachs said declining economic activity in Europe and China and better-than-expected credit conditions in the U.S. were the bearish factors for the euro.
The American firm said in May that the regulatory backdrops in the U.S. and Europe did not support bulls for the euro. The U.S. Federal Reserve was close to a “sufficiently restrictive” monetary policy setting. At that time, the ECB also signaled that it was nearly done with rate hiking.
In a recent speech, ECB president Christine Lagarde said the European inflation rate was still “too high” for officials to consider a policy pivot. Headline inflation in Europe stood at 6.1 percent in May, down from seven percent the month before. The ECB’s inflation target is two percent.
“This persistence is caused by the fact that inflation is working its way through the economy in phases, as different economic agents try to pass the costs on to each other.”
Christine Lagarde, ECB president
The ECB began its monetary tightening campaign in July 2022 to battle soaring inflation in the bloc. This month, the central bank hiked its key rate by 25 basis points to 3.5 percent. Analysts predict that the ECB will deliver another rate hike in July.
Goldman Sachs advises forex investors to take a long position in EUR/SEK as an inflation hedge. The bank predicts the EUR/SEK exchange rate to hit 12.00 by the end of the year. According to Goldman Sachs strategists, the long position in EUR/SEK will protect investors from stubborn inflation and high-interest rates.
Analysts explain that Sweden experiences a “more challenging” trade-off because its economy is sensitive to policy changes. Sweden’s economy also has more exposure to the manufacturing sector than some other European countries.
Capital flows in Europe
According to Goldman Sachs, capital flows in Europe provide limited support to the shared currency. Analysts point out that “positive” yields have helped the bloc’s return to gradual inflows by stopping outflows from its fixed income. However, the speed of inflows did not match the outflows when the EUR/USD rate went negative last year.
Recent data suggests that capital flows in the EU have stayed the same since the 2007 global crisis. Cross-border financial claims represented nearly 100 percent of the region’s gross domestic product last year, similar to 2007.
Analysts note that private investment largely concentrates within the northern part of the EU. The market considers investment risk in southern and eastern Europe “too high,” despite higher potential returns. Last year, southern Europe received about 50 percentage points less capital from other European countries than in 2008.
The gap in capital flows prevents the EU from gaining the “full benefits” of its shared market, say analysts. The financial fragmentation also limits the region’s ability to form appropriate responses to external economic shocks.
Economists say public subsidies can be a solution to the problem. They also suggest the EU strengthen its banking and capital markets union to boost private risk sharing.