Image © European Central Bank

The Euro to Dollar exchange rate (EURUSD) recovery is effectively over, according to a new analysis from European lender and investment bank ABN AMRO.

The Dutch-based bank says the European Central Bank (ECB) will surprise markets by cutting interest rates before the end of 2023 but the U.S. Federal Reserve will only follow suit later in 2024.

"For the ECB we are less hawkish in 2023 and far more dovish for 2024," says Georgette Boele, Senior FX Strategist at ABN AMRO, announcing her bank's latest foreign exchange forecast changes.

If correct, this would make for a contrast in the future of monetary policy at the Fed and ECB, to the detriment of those looking for a stronger Euro.

This view is not a consensus one, which makes it all the more relevant. For instance, we reported most recently an analysis from UniCredit Bank that revealed the Euro-Dollar would embark on a more sustained rally in 2024 as the Fed cut rates faster and by a greater amount than the ECB.

An ECB rate cut ahead of the Fed, that confounds consensus expectations, would put the Dollar on course for a prolonged spell of outperformance against the Eurozone's single currency.

ABN AMRO now expects the last U.S. rate hike of 25bp to be delivered at the July meeting. A U.S. recession is forecast to start in the fourth quarter and the first cut is to come in the first quarter of 2024.

An aggressive path of rate cuts from the Fed is still expected in 2024, "but 50bp less than we originally had," says Boele, "we now have a total of 175 basis point of rate cuts in 2024."

Above: Investor positioning on the Euro is at multi-year highs, which poses a significant downside risk if consensus expectations are challenged. Image courtesy of ABN AMRO.

By contrast, the ECB will hike the deposit rate to a peak of 3.75% (consensus sees more) and the first rate cut to come at the end of 2023, says ABN AMRO.

For 2024 the bank predicts a total of 150bp of rate cuts by the ECB compared to consensus expectations of 75bp from a higher level.

Based on these expectations, "we have downgraded our forecasts for EUR/USD," says Boele.

"First, we no longer have a rate cut for the Fed this year and fewer total rate cuts in 2023-2024. This is a positive for the US dollar. Second, if the ECB starts cutting rates already in December – contrary to market expectations – the euro will suffer. Third, aggressive rate cuts by the ECB in 2024 will put more downward pressure on the euro than Fed cuts will on the dollar," says Boele.

She adds that the speculative positions in the euro "are extremely large" and if investors partly give up on their views of a higher euro and liquidate part of these positions, "the euro will also come under pressure".

ABN AMRO has downgraded its forecasts for EUR/USD to reflect the dynamics above, but there are risks that the downside is greater than these forecasts imply.

"This is because it is difficult to forecasts how far and how long position liquidation will run," says Boele.

The bank's new forecast for the end of 2023 is 1.08 (down from 1.10) and for the end of 2024 1.05 (down from 1.10).