EUR/USD: Improving rate differentials should continue to support the Euro over the near term – HSBC

Central bank policy divergence in the months ahead should see a stronger EUR, in the view of economists at HSBC.

More strength ahead

We expect the ECB to deliver two more 25 bps rate hikes through the summer, vs just one more 25 bps hike by the Fed (albeit with upside risks). As such, the balance of risks from a short-term rate dynamic should continue to support the EUR over the near term.

Beyond short-term assessments of meeting-to-meeting central bank decisions, we believe there are structural reasons for more EUR strength ahead. The broader shift by the ECB into positive nominal rate territory and towards Quantitative Tightening (QT) has driven a bigger underlying change in portfolio flow dynamics. The last year has seen notable bond and equity inflows, which are unlikely to reverse any time soon and which should be EUR-positive.

Other external flows should also support the EUR. Over the past few years, the EUR’s performance can be explained to a certain extent by current account dynamics. Improving terms of trade are likely to support an ongoing current account surplus in the region, justifying a stronger EUR.