Euro vision for lower Aussie

The Australian dollar has slipped against the euro … and that’s set to continue.

Summary: Strengthening economic conditions across Europe have eroded the exchange rate between the euro and Australian dollar. As that trend continues, economists expect more $A slippage over time.
Key take-out: A falling dollar against the euro presents opportunities for those who want to capture the currency benefit.
Key beneficiaries: General investors. Category: Foreign exchange.

The Australian dollar’s fall against the greenback has been widely documented, but in the shadows another currency has been making strides against the Aussie.

You may not know it but since the start of the year the Australian dollar has fallen more than 12% against the euro … and experts say its descent isn’t over yet.

“The euro will continue to strengthen against the [Australian] dollar as the global recovery solidifies and becomes more entrenched and the region’s tail risks diminish,” says Richard Yetsenga, head of global markets research at ANZ.

“Our forecasts over the next year have the Australian dollar depreciating 5-10% against the euro,” he says.

That could potentially bring it to about 62 cents, back to where it was in late 2009, although the Aussie has regained some strength in the past week on the back of encouraging economic data.

Shane Oliver, head of Investment Strategy and chief economist at AMP Capital, is forecasting a similar decline for the Australian dollar, not only against the euro but also against the greenback.

“I think ultimately it will continue to depreciate. Against the US dollar it’s probably heading toward 80 cents, against the euro, [probably] 62/63 cents over the next 12 months to two years,” he says.

Chief economist at BT Financial Group, Chris Caton, and chief economist at Citigroup, Paul Brennan, also believe the dollar will fall further, though not by as much.

“I think it’s possible it would fall another 5%,”Caton says.

Meanwhile, Brennan says Citigroup’s forecasts are for the Australian dollar to fall against the euro by around 3% over the next 12 months.

It’s a markedly different picture from a year ago when the talk was of a looming euro area break-up and the threat of a “Grexit” (Greek exit). But expected or not, the tail risks do look to be receding. The region has just clawed its way out of recession, recording 0.3% growth in the three months to June. It’s got a strong current account surplus on rising exports, while business conditions and confidence measures are also pointing in a positive direction.

At the same time, the Australian economy is deteriorating relative to the US and Europe. That’s not to say that Australia’s in worse economic shape than either region, but in a general sense the sentiment out of Australia is less positive than that out of Europe and the US.

In Europe it’s one of improvement, albeit from a low base. In contrast, in Australia talk is of a slowdown in the economy and rising unemployment.

Changing fortunes

Money always flows towards opportunity. A few years ago foreign investors were parking their money in Australia to get a yield pick-up of 4% or so. That’s no longer the case. Right now it’s flowing to the US and Europe.

“The news flow in Europe has been a bit more positive so money has been flowing into the region to some degree and the euro’s been a bit stronger,” says Oliver. “Foreign investors see opportunities there.

“That’s all being reinforced by the view that the best is probably over in terms of the commodities price surge and the mining boom.”

Citi was one of the more bearish commentators on Europe, Brennan says. The recent change in the region’s fortune means they’ve had to raise their forecasts.

“For 2013 we’ve raised our growth forecast from -0.7% to -0.5%. In terms of next year, we’ve got growth at 0.6% as opposed to our previous forecasts of another year of recession,” he says.

General consensus seems to be that the worst is over for the embattled region.

Australian investors

So where does that leave Australian investors?

A falling dollar presents opportunities for those who want to capture the currency benefit, either through domestic companies with exposure to the euro or European-based listed companies.

Oliver says the ideal time to invest in Europe was in 2011, when it was at the bottom of its cycle, although it’s pretty safe to say that would have only been a move for the very brave.

Still, he sees further opportunities now.

“I think the Australian sharemarket will go higher, but I think there are better prospects in Europe. The overall PE in Europe is 11 times, in Australia it’s 14 times. I think it does make sense for investors to look at Europe,” he says.

For David McDonald, chief investment strategist at Credit Suisse, Germany is one markets investors should look at.

“We think that Germany particularly is an attractive market. Exporters are doing well and the cyclical side of Europe generally is something we would focus on including engineering and automotive, [sectors] that benefit from the US recovery as well as Europe picking up,” he says.

Financial stocks globally, including Europe, are another focus for Credit Suisse right now, says McDonald.

But there are still obvious risks with investing in Europe. It’s very early days for the recovery in Europe, and any political instability could set the region back again. What’s more, to a large extent the partly export-led euro recovery is a derivative of the recovery in the US and China, meaning it is sustainable as long as the global recovery continues.

The periphery countries are still weak and the fundamental issues that saw the near collapse of the region have yet to be been fully addressed. But there’s no denying the shift in growth expectations for Europe. It certainly presents investors with an opportunity, albeit a risky one.