The continued strength of the euro has analysts baffled. Purely on economic fundamentals, the single currency looks overvalued against both the US dollar and pound sterling. However, cash continues to flow into the market, particularly peripheral sovereign bonds as investors search for yield, thus keeping the euro strong. While demand for such bonds should remain robust in the first half of 2014, the possibility of further monetary easing from the European Central Bank [ECB] and potential quantitative easing is likely to eventually impact negatively on the currency.
- The US Federal Reserve and the Bank of England are both likely to raise interest rates before the ECB does.
- While Germany is holding its own, the other major countries in the bloc continue to struggle, particularly France and the Eurozone as a whole is likely to under-perform both the US and UK in 2014.
- Eventually, the euro must move sharply lower versus both the dollar and sterling as a result.
- Normally, Sterling should be trading somewhere between 70p and 75p against the Euro.
- The UK economy is recovering strongly and set to be the fastest growing of the major G7 bloc in 2014 and 2015, with the increase in real GDP to be twice as much as that of the Eurozone.
- UK house prices are rising sharply, adding to the view that the Bank of England will be forced to raise interest rates sooner than it is currently saying.
- UK inflation is likely to exceed the official 2.0% target level over the next 12-18 months, supporting the need for a strong currency.
- A quickly improving UK labour market should lead to higher wages this year, in turn putting more upward pressure on inflation.
- With a General Election next year, politicians will be well aware that the general public likes a strong currency so they can avail of cheap sun holidays abroad, another reason why the pound should strengthen over the next year or so.
Analysts predict that sterling will begin to strengthen this year and by 2015, is likely to trade between 75p and 80p.