Exchange Rate Forecasts

The euro dollar exchange rate is currently 0.31% higher on yesterday at 1.3185.

A morning exchange rate forecast note from Bank of America Merrill Lynch points to the euro dollar exchange rate staying within the 1.25-1.3 range this year. There are however risks to both the downside and upside:

Advertisement - Article Continues Below

Bank of America analyst Athanasios Vamvakidis writes: 

"If the periphery enters a Greek-style vicious cycle, in which fiscal consolidation, a credit crunch, delays in reform implementation and uncertainty about the end-game deepen the recession and worsen debt dynamics, the ECB would likely loosen policies further and the global recovery could be at risk, weakening the EUR.

"However, if the global recovery gains steam, the US avoids fiscal tightening this year, reform-oriented governments in the eurozone periphery succeed, or the FED surprises with QE3, the EUR could strengthen further.

The story for euro dollar thus far in 2012

The recent risk-on market move has reversed the EUR weakening trend that started during the second half of last year.

Although the EUR remains well below last year’s peak, it has recently been supported by positive data in the US and China that have triggered demand for risky assets.

A dovish Fed has also weakened the USD.

And the ECB’s LTRO has helped address tail risks in Europe’s banking system. The positive market momentum is so strong, that many seem to forget that the recent EUR rally is only two weeks old.

However, concerns about the periphery could come to the fore again warn Bank of America.

"Although we expect an agreement on the PSI scheme in Greece, participation is likely to be less than the program assumption (PSI in Greece: an agreement remains likely)," says Vamvakidis.

This could fuel concerns about a default, even if the ECB agrees to give away what would otherwise be a profit on its Greek holdings.

The exchange rate analyst also expect the negotiations for the new program in Greece to be difficult, as the public reacts to additional austerity measures during a deepening recession (see Believe it or not, Greece remains a blind spot).

Recent concerns that a PSI scheme could be an option for Portugal, if markets remain closed to the country next year, is a reminder of possible indirect contagion from the way the Greek crisis is handled.

"The above point to continued range movements in the EURUSD this year, although below last year’s range," says Vamvakidis.