Force of flows to keep EUR afloat – Danske Bank

While relative rates are often regarded as a key driver of FX, rates could become of second order in an environment where the potential for central banks to hike rates is limited, according to analysts at Danske Bank.

Key Quotes

“As the ECB and the Riksbank embark on a path to ‘normalisation’ of policy, we see potential for portfolio flows to become a key source of EUR support. Eurozone capital flows should eventually reverse from currently large outflows to become inflows. While such flows may be partly hedged, our integrated rate-flow framework suggests that in the past these have been a significant driver of EUR/USD. The potential for a Riksbank ‘exit’ (eventually) to drive a reversal in capital flows is limited in our view, as over the past decade Swedish flows have been linked more to the euro debt crisis than to the Riksbank’s ECB shadow policy.”

“Within our rate-flow model, we can illustrate the possible longer term implications of a ‘normalisation’ of ECB and Riksbank policy. For EUR/USD, even if the EU-US rate spread narrows only slowly, the potential support to the euro from a reversal in, notably, debt flows leaves risks in EUR/USD skewed on the upside with 1.35 within reach as ECB ‘exits’. For EUR/SEK, a more negative EUR-SEK rate spread should support the krona but the EUR-positive flow factor could largely counter this, thus limiting the potential for EUR/SEK downside significantly, leaving the cross above 9.40 longer term.”