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Barclays has raised its forecasts for the Euro to Dollar exchange rate in 2023 but warns the pair could yet end the first quarter lower than at current levels.

Analysts at the investment bank say they lift their forecasts for the Euro against the Dollar based on expectations for an easing in gas prices, the reopening of China's economy and a maturing Federal Reserve tightening cycle.

The call comes amidst an ongoing outperformance in EUR/USD which has risen 1.30% in 2023, adding to its 12% advance from a September 26 nadir at 0.9543 to the year-end close of 1.0660.

Spot is located at 1.0840 at the time of writing, its highest level since April 2022, meaning bank payment rates are now close to 1.0539, competitive cash and holiday money providers are near 1.0745 and competitive payment providers near 1.0810.

For sure, the rally is primarily driven by a significant reappraisal of the Eurozone's growth prospects in light of falling gas prices and elevated gas storage levels.

"Strikingly, natural gas prices are at pre-Ukraine war levels thanks to a mild winter, implying a reduction in the euro’s energy risk premium but also skewing risks to the upside," says Themistoklis Fiotakis, Head of FX Research at Barclays.

But the fundamental economic improvements come alongside communications from the European Central Bank (ECB) that at least two further 50 basis point interest rates will be delivered in early 2023 in order for inflation to be brought back under control.

"The ECB's recent hawkish pivot should support medium-term upside," says Fiotakis.

This implies more hikes are to come from the ECB than the Federal Reserve in 2023: in the wake of January 12's inflation data release markets now see a 25bp hike in February and speculation has risen that this could be the last of the cycle.

But of more significance is that money markets now price in approximately 150 basis points of rate cuts by the first half of 2024, which is well in excess of the approximately 50bp expected from the ECB in that period.

In short, interest rate dynamics are notably in favour of Euro-Dollar upside.

Above: EUR/USD has risen 14% since its September bottom. Consider setting a free FX rate alert here to better time your payment requirements.

But Barclays says its forecast upgrades still reflect the risk that gas prices spike again and compromise sentiment on the Eurozone's recovery prospects.

"A renewed surge in commodity prices (incl. oil and natural gas), as Chinese demand picks up amid high geopolitical tensions. This risk underlies our near-term EURUSD forecast," says Fiotakis.

Barclays now holds a EUR/USD forecast of 1.04 for the end of the first quarter, which implies some retracement over the coming weeks as "near-term bumps" are encountered.

Another near-term downside risk lies with the Fed: although it looks set to slow the pace of rate hikes it might show discontent with the fall in U.S. yields, which presents an effective easing in monetary conditions.

The Fed might judge that with core inflation remaining near elevated levels the cost of money is falling too fast, too soon.

But beyond the first quarter, the gates open to a more durable Euro-Dollar recovery.

"We have lifted our EURUSD forecast to 1.12 by end-23 (from 1.05) thanks to a faster exit from zero-COVID in China and a maturing tightening cycle by the Fed given signs that US inflation is peaking," says Fiotakis.

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