The Standard Bank still believes that the euro’s direction will be skewed a little lower in the early months of the year towards the 1.05-1.10 range against the dollar.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy expects volatility in the euro to be higher in 2022 than in 2021. The early part of the year could see the euro weighed down by a number of factors; most prominently the persistence of a more expansionary monetary policy setting compared to many others, and an increase in political risk. But as the year moves on, the euro will recover, at least against the dollar, while strength against other developed currencies may be harder to come by.

On monetary policy, it is clear that many other major central banks will be ahead of the ECB when it comes to tighter monetary policy, and hence interest rate differentials could move against the euro. But we saw when the Fed hiked rates between 2015 and 2018, without any move from the ECB, that the euro could still rise. Hence, while rate differentials are important, they are certainly not the sole factor driving the euro.

What’s more, the ECB should start its own rate-hike cycle, possibly in 2023, unlike last time when Fed rate hikes went unanswered. Another issue to consider is the movement of real (inflationadjusted) yields, as changes here will likely be far larger than those of nominal rates given the huge volatility that’s still likely in inflation and possibly also inflation expectations.

"Our concern is that the Fed has a trickier inflation problem on its hands than the ECB and, if that’s right, it could limit  any dollar strength against the euro and possibly aid the euro against other (riskier) currencies should any Fed struggle with inflation prompt a bout of heightened risk aversion. Nonetheless, we still believe that the euro’s direction will be skewed a little lower in the early months of the year towards the 1.05-1.10 range against the dollar. Domestic politics and geopolitics threaten to exacerbate any early-year euro weakness", Mr. Steve Barrow said.

There are two pressure points to keep in mind. One possibility is that current Italian Prime Minister Draghi, the former ECB President, will run for Italian President later this month, potentially leaving a void that will be filled by months of political wrangling over a new PM and an eventual victory for those on the right who are more skeptical of EMU.On top of this, French presidential elections in April will likely see the usual concerns about a victory for the far right, with similarly sceptical EMU overtones. All the while, geopolitics could turn ugly, should speculation of a Russian incursion into Ukraine prove prophetic.

The euro could move to 1.25 level against the dollar by the end of 2022

But while there are risks to the euro early in this year, we’d not overplay the downside, and we also expect the euro will shake-off any early-2022 nerves as the year wears on. For instance, the economic recovery that will likely follow the waning of the Omicron variant of COVID should weigh against ‘safe’ currencies such as the dollar, yen, and Swiss franc. In addition, once the Fed gets started with rate increases, the dollar tends to start slipping back. It seems that the anticipation of higher US rates aids the dollar more than the rate hikes themselves, particularly if inflation is moderating and the Fed hikes no more than expected.

"As we move towards 2023, speculation should increase about the start of rate hikes by the ECB. All this is expected to help lift the euro back up to the 1.25 level against the dollar by the end of 2022. Other currencies are likely to appreciate against the dollar as well, and hence we see the likes of euro/sterling and euro/yen ending in 2022, not far from where they started. In all, we think it will mean that the euro will reverse the 4%, or so, trade-weighted fall that we saw in 2021", Mr. Steve Barrow said.