While any early rate cut may weigh on the euro, it is not a basis for sustained weakness.

The US dollar is likely to weaken moderately through next year as the tightening cycle turns to an easing cycle. Provided this bolsters asset prices, and sets off a more positive global financial cycle, the US dollar should fall. But the slide will be uneven and one currency that may not benefit as much as others, is the euro.

The euro has come under some modest pressure recently against other developed currencies such as the yen, sterling and Swiss franc with much of this seemingly down to speculation that the ECB could rush through rate cuts ahead of most others. In the Standard Bank’s view, it is a reasonable bet that the ECB will be quick off the blocks to ease given that the economy looks very vulnerable and inflation has come down at speed.

In addition, ECB members seem more willing to discuss the issue of future rate cuts than their peers in other central banks. The Standard Bank expects that the ECB will start the rate cut process in Q2; a few months ahead of the Fed. But while any early rate cut may weigh on the euro, it is not a basis for sustained weakness. Other central banks will join in with cuts of their own soon after the ECB and, as we have said before, easing cycles that include, or are led by the Fed, tend to see a higher euro against the dollar as the greenback’s safe-asset premium diminishes.

The Standard Bank expects the same to happen in the upcoming easing cycle and that should help lift the euro to the 1.20 region against the US dollar. However, strength on a cross-rate basis may be harder to come by for a number of reasons. On the monetary policy front, it needs to bear in mind that there’s likely to be a countertrend tightening of policy from the Bank of Japan, and that seems likely to accelerate the recent downtrend in euro/yen. But as well as losing ground to a ‘safe’ currency such as the yen, the euro will fall against ‘riskier’ G10 currencies such as the Australian dollar, NZ dollar and Scandinavian currencies.

An easing cycle from the Fed is likely to cause a decline in risk aversion amongst investors with both bond and stock prices moving higher. Such ‘risk-on’ sentiment should strengthen ‘risk’ currencies more than it does the ’safe’ currencies – with the exception being the yen given the BoJ’s countertrend policy tightening. Of course, if this assumption proves incorrect and the Fed eases into a massive risk-off period then the euro is likely to appreciate against the riskier currencies – but lose out to the dollar.

One currency that we have not discussed very much so far is the pound. Sterling has traded in a very stable fashion against the euro since the 2016 Brexit referendum. The referendum result was an adverse shock for the UK economy that financial markets priced in just about as soon as the referendum result was known. The UK’s subsequent economic performance suggests that this immediate surge in pessimism towards the economy – and the pound – was fully justified. Hence it has seemed that the prospects of euro/sterling slipping back to the pre-referendum range of 0.70-0.75 had gone for good.

However, over time, the Brexit disturbance would bed down. If we add to this the opportunities that come from things like breaking free from EU regulations and negotiating new trade deals, then there seems to be a possibility that the pound could ultimately return to these pre-referendum levels. This being said, we are not sure at all it is going to be next year, and maybe not the year after that.

Nonetheless, the risks are skewed to the low side for euro/sterling over the long haul. A return to the 0.70-0.75-pre-referendum range may be out of reach, but sub-0.80 levels should be achievable. That just leaves the Swiss franc of the major developed currencies. Unlike the pound, the franc has enjoyed almost unending strength against the euro for many years. This could be challenged should a big risk rally develop as the Fed eases, as the franc is usually regarded the safest asset and hence has the most to lose. Putting all this together, we’d argue that the euro is most at risk of weakness against the yen.