No ECB rate hike until 2019 but euro drop may be ending

By most measures 2015 was a vintage year for Irish exporters.

National accounts data show exports have posted six consecutive quarters of double-digit growth on an annual basis.

The merchandise trade surplus for the first 10 months of 2015 rose by an astonishing 43% to €38 billion.

The latest Investec Services Purchasing Managers’ Index survey suggests the rate of growth in new export business quickened to a 14-month high in November.

Some of this growth is flattered by multinational-specific factors.

However, other releases indicate that indigenous firms are benefiting from healthy overseas demand – for example, industrial production volume data for this segment show the first half of 2015 saw the strongest growth in two decades.

Moving from the macro to the micro level, in a further sign of export resilience Investec’s treasury units in Dublin and Munster have both seen an upturn in enquiries from Irish SMEs looking to hedge their currency exposures.

So what were the key drivers of this growth?

Euro weakness was a key tailwind, as approximately two-thirds of Irish exports go to countries that do not share the single currency.

In 2014, the average euro-US dollar and euro-sterling exchange rates were $1.33 and £0.81 respectively.

At the time of writing it appears the 2015 averages for these currency pairs will be $1.11 and £0.73.

These double-digit declines have helped to enhance the attractiveness of Irish exports to two key trading partners.

Another important factor, and one that is not unrelated to the above currency moves, is the robust growth being turned in by the US and UK — where we estimate GDP expanded by 2.5% and 2.4% respectively in 2015.

The above currency moves have been driven by shifting monetary policy expectations.

In the wake of the global financial crisis, the US central bank — the Federal Reserve, the Bank of England and the ECB all gradually eased their policy settings in a bid to revive their economies.

Going into 2015, markets had come to the conclusion at least one of these —namely the Fed — would tighten policy, possibly followed by the Bank of England.

The ECB was expected to keep policy loose — and indeed, we don’t see any ECB tightening until 2019.

Such a policy unwind is not without risks.

In June 2003, the Federal Open Market Committee — the FOMC — met to agree its final cut in that rate cycle.

In the event, it started hiking rates again just 12 months later. Perhaps with foresight of what was to come, the meeting transcript contains an amusing anecdote from the Committee’s secretary, Vincent Reinhart.

He told members: “I was in line at midnight on Friday with my 11-year-old son to purchase Harry Potter and the Order of the Phoenix.

“At 870 pages it is somewhat longer than the briefing documents the Committee has received.

“But it, too, considers an alternative world filled with uncertainty and great perils!”

Fearing such perils, the prospect of a rate rise saw currency traders flock to buy the dollar.

The trade-weighted dollar index measures the strength of the US currency relative to its peers.

The index has increased by 20% since the start of 2014.

In a ‘flight to safety’, traders offloaded emerging market currencies, particularly those of commodity exporters.

There were notable falls recorded by the likes of the Brazilian real and Mexican peso.

On December 16, the FOMC raised US rates for the first time in nine years. So, will the dollar continue to soar against the likes of the euro?

Historical precedence — the dollar index moved lower in the months following the start of the two previous rate hike cycles.

History therefore does not provide grounds for optimism.

We see the dollar peaking at around $1.06 to the euro in the early new year, before weakening to $1.15 by the end of 2016.

The narrative is broadly similar for sterling.

While expectations of a 2015 Bank of England rate hike having been premature, markets foresee a tightening by next autumn.

Taking its cue from the dollar’s performance ahead of the recent FOMC move, this should see sterling rise against the euro in the short term.

We think sterling can go to 69 pence against the euro by the end of the first half of 2016, before its ascent is arrested.

In the background, the so-called Brexit referendum on whether Britain will exit the EU could prove a headwind for sterling.

That’s if opinion polls indicate a shift in support towards the anti-EU side.

Pulling it all together, the very favourable conditions for Irish exporters seen in 2015 appear set to give way to a more mixed backdrop in 2016. The single currency is likely to have strengthened against the currencies of many Ireland’s key non- eurozone trading partners by this time next year.

Our advice to exporters is to consider how this is likely to affect your business.

And then to contemplate ways to protect against any downside.

Philip O’Sullivan is chief economist at Investec Ireland


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