November 2, 2015 / 11:42 AM / 4 years ago

UPDATE 1-Big banks cut euro, German yield outlook as ECB easing looms

(Adds details on more banks.)

By Jamie McGeever and Anirban Nag

LONDON, Nov 2 (Reuters) - Big investment banks are cutting their forecasts for the euro and euro zone bond yields as the divergence between U.S. and euro zone monetary policy looks set to widen, potentially in dramatic fashion next month.

Morgan Stanley on Monday said it now expects the single currency will fall to $1.03 early next year, and Citi said 10-year the German Bund yield could go as low as 0.1 percent.

The forecasts assume the European Central Bank will expand its quantitative easing bond-buying programme next month and cut its deposit rate further below zero.

Both U.S. banks expect the ECB to cut its deposit rate 10 basis points at its Dec. 3 meeting to -0.3 percent and increase its monthly asset purchases by 15 billion euros to 75 billion euros.

By contrast, the U.S. Federal Reserve is widely expected to raise rates in coming months. The chances are 50-50 it will move at its next meeting, on Dec. 15-16, according to current market pricing.

“We expect the euro to come under renewed selling pressure going into the end of the year and early next year as a result of the increased potential for further easing from the ECB,” Morgan Stanley currency strategist Ian Stannard said.

Morgan Stanley forecasts the euro at $1.03 by the end of the first quarter of next year, compared with $1.11 previously, and ending next year at $1.00. On Monday it was at $1.10.

For its part, Citi expects the ECB’s aggressive loosening to push Bund yields as low as 0.1 percent within the next six months. Its previous estimate was 0.5-0.6 percent.

The ECB left policy unchanged at its last meeting, but president Mario Draghi indicated that more action to fight off the threat of deflation is on the cards, probably at its next meeting, on Dec. 3.

The overwhelming view now among economists and financial markets is that the ECB’s 1 trillion-euro QE programme will be expanded and extended and the deposit rate cut.

The 10-year Bund yield fell to a record low of 0.05 percent in April, before snapping back above 1 percent by early June in a so-called “flash crash”. On Monday, it was hovering around 0.55 percent.

Citi’s 0.1 percent call is among the most aggressive of the major investment banks. Earlier this year it forecast -0.05 percent but abandoned that in May, saying that it would close this year around 0.4 percent.

Last month, HSBC said the Bund yield would go as low as 0.2 percent next year.

HSBC’s euro forecast is the outlier among the big banks. It sees the euro rising to $1.20 next year because the Fed won’t raise rates as high or as fast as markets expect.

Most banks, however, expect the widening U.S.-euro zone policy divergence to push the euro lower. Goldman Sachs and Deutsche Bank are among the most bearish, forecasting an eventual decline in 2017 to $0.80 and $0.85, respectively. (Reporting by Jamie McGeever and Anirban Nag, editing by Larry King)

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