Outlook for major currency pairs to depend on world economic recovery

DURING the economic crisis, many central banks cut interest rates to near-zero and introduced further monetary expansion through asset purchase policies. With all major economies suffering from recession and little interest rate differential, currency traders looked to daily fluctuations for their profits. <br /><br />But with the global economy showing signs of a more entrenched recovery and central banks starting to consider hiking interest rates &ndash; or in the case of the Reserve Bank of Australia (RBA) actually raising them &ndash; what is the outlook for the three major currencies &ndash; US dollar, euro and sterling &ndash; over the next six months or so?<br /><br />The US dollar, which has seen its reserve currency status come under fire in recent weeks, is expected by analysts to remain weak in the coming months, particularly if equity markets gain in strength and confidence grows. However, a wholesale collapse of the US dollar is not anticipated as there are too many market participants &ndash; emerging market central banks, for example &ndash; with a vested interest in a stable dollar. <br /><br />BNP Paribas analysts are bearish on the dollar and think that, although the euro-dollar pair has struggled in advance of the 1.5000 level, it just seems a matter of time before this level is breached.<br /><br />The European Central Bank (ECB) has already expressed its displeasure over a strong euro, but unfortunately for president Jean-Claude Trichet and co, there seems to be room for the single currency to strengthen against both the pound and the US dollar. <br /><br />George Tchetvertakov, head of market research at forex provider Alpari UK, says: &ldquo;I think the euro will definitely test parity against sterling because the momentum is definitely on the upside, and believe there is scope for the euro to go beyond parity.&rdquo;<br /><br /><strong>HAMPERING RECOVERY</strong><br />But the euro is at risk of becoming overvalued against both the dollar and the pound if it continues to strengthen sharply. This will hamper a recovery in the Eurozone and weaken the bloc&rsquo;s competitiveness, with a potential downward effect on the single currency.<br /><br />Indeed, Mark O&rsquo;Sullivan at Currencies Direct says that he would not be surprised if the pound managed to stage a sharp rally against the euro in 2010 as it has been remarkably oversold of late. But such a recovery would depend on the relative pace of the economic recovery and whether the Bank of England manages to play its quantitative easing policy successfully or not. <br /><br />Euro-sterling used to be one of quietest currency pairs, barely moving on a daily basis. But now, O&rsquo;Sullivan says it is one of the most contentious and can fluctuate sharply. <br /><br />He thinks that the pound will still underperform on average over the next 12 months and it could reach parity against the euro over the next months. If sterling does move lower in this way, then O&rsquo;Sullivan thinks that this would be a good level for traders to pick up the pound. <br /><br />Economic fundamentals and monetary policy will dictate how the major currencies will move over the next six months. With both the US dollar and sterling expected to remain weak against the euro, traders should look for short-term opportunities to capitalise on any divergence from trend.<br />