Capital Economics - "While the euro may well strengthen further in the near term, we still expect it to weaken again later in the year as worries over the currency union resurface. In the meantime, though, the strong currency is another factor hindering a vital return to growth in the uncompetitive peripheral economies.
The recent strength of the euro against the US dollar has no doubt largely reflected the lull in the euro-zone debt crisis since the ECB unveiled its plans for Outright Monetary Transactions (OMTs) last autumn. The near 10% rise in the euro from $1.22 to $1.34 since last July has coincided with a fall in the implied probability of a country leaving the euro-zone by the end of this year from over 60% to just above 10%. At the same time, though, the euro has received an additional boost from several dollar-negative developments, including the implementation of a third bout of quantitative easing in the US and the concerns over the so-called fiscal cliff.
These sorts of forces may very well push the euro higher over the coming months. It is not obvious what might cause the euro-zone crisis to flare back up again in the very near term. Meanwhile, US fiscal worries are likely to intensify if negotiations over the impending government spending cuts go right to the wire as the debt ceiling approaches. Against this background, we can easily see the euro climbing to $1.40 by the middle of the year or sooner.
Further ahead, though, we still believe that the economic fundamentals point to a weaker euro.
(...) Admittedly, our previous forecast that the euro would drop all the way to parity against the dollar looks too low, given the higher starting point. But we still think the euro could drop back to around $1.25 by the end of the year and certainly would not rule out a bigger fall. The longer it stays higher, however, the more unhelpful it will be."