Euro could hit $1.20 by year end as Draghi spurs rally: analysts say

Key Points
  • Euro could hit $1.20 before the end of the year, suggests analyst.
  • Improved euro zone data and political setbacks in the U.S. could help the euro rally.
  • ECB held interest rates steady Thursday but pointed to plans to begin tightening discussions in September.

could be on track to hit $1.20 against the dollar before the year is out, according to analysts who say that it is set to ride a wave of improved euro zone data and weakening investor conviction in the U.S.

The single currency hit a two-year high of $1.1655 against the dollar Thursday after European Central Bank (ECB) President Mario Draghi said the euro zone was showing signs of "unquestionable improvement" and pointed to plans to begin discussing possible changes to its quantitative easing (QE) program in the fall.

In early deals Friday it moved higher to $1.1668, up significantly from the low of $1.1488 seen in the immediate wake of the ECB's decision to keep interest rates on hold. Analysts suggest that the upwards momentum is set to continue.

UniCredit: Expect higher EUR/USD in the next few months

"I think euro/dollar has started moving towards equilibrium," Vasileios Gkionakis, managing director and co-head of strategy research at Unicredit, told CNBC Thursday.

"It has been undervalued for quite some time, and now the market has started pricing in that upcoming normalization from the ECB."

When will the ECB taper?

Draghi did not set a time frame for tightening, however, analysts anticipate that the central bank could announce in September plans to reduce its asset buyback program from early 2018, before moving to gradually hiking interest rates from the following year.

"Investors believe that the ECB QE programme will go to 40 billion euros per month during the fourth quarter of 2017 and that the negative deposit rates will go. This has been my view for the last three months and I assume that QE will end in 2Q18," Bob Parker, investment committee member at Quilvest Investment Management, told CNBC via email Thursday.

These indications mark a positive for the euro. It has suffered a volatile ride since lows of $1.0404 in January but has shown broadly upwards momentum against the dollar which has been hit by a number of political setbacks in Washington.

How high can the euro go?

For Parker, this could see the single currency run as high as $1.20 by the end of the year, before rising further to $1.25 in 2018.

"The background is that all euro zone data shows as uptrend and deflation risk is greatly reduced. Conversely, the recent U.S. retail and inflation data are weak suggesting that the Fed will moderate its interest rate increases," said Parker.

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"I stick to my forecast of $1.20 during 4Q17 and $1.25 during 2Q18."

Gkionakis agreed that the currency would likely go higher, though tempered his estimates.

"I think it's more likely that it will go higher," Gkionakis said. "We can get these back and forths ... but I think it's quite clear that the economic dynamics are moving in the right direction in the euro zone.

"Our forecasts are a bit on the cautious side right now — we currently have it at $1.14 by year end — but I certainly see the risks to the upside," he added.

ECB keen to avoid mini tantrum

The ECB will be acutely aware, however, of how its signals impact the market and will be keen to avoid another mini tantrum like that seen in late June, when Draghi's hawkish tone during an ECB Forum in Sintra, Portugal set the euro higher.

BNP Paribas' head of European market economics, Luigi Speranza, suggested that investors should expect the ECB to quickly step back in if the gains move too quickly.

"Should the euro strengthen further from here, we would not be surprised if, over the next few days, the ECB were to ramp up its rhetoric on the risks posed by tighter financial conditions to the growth and, more importantly, inflation outlook," Speranza wrote in an email.

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