Broad dollar strength on the horizon, says Wells Fargo

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The dollar is expected to make broad-based gains against its major peers over the next 12 months as expectations grow for a 25 basis point rate hike at the Federal Reserve's December meeting, says Erik Nelson, currency analyst at Wells Fargo, which topped last week's three-month forecast table.

"In our view, central bank actions, both actual and expected, remain the pre-eminent drivers of exchange rates," says Nelson, who believes the US central bank could hit the accelerator next year, propelling the dollar to become stronger against the euro, the yen, the British pound and the Swiss franc.

Historic low

The dollar slid against the yen on October 3, trading at 101 versus 103 on July 1. But the greenback has maintained its strength against the struggling pound, with cable trading at 1.29 on the same day, against 1.33 three months ago. Wells Fargo made a spot-on call for both pairs.

The pound has hit historic lows since the British public's vote to leave the European Union, and after a brief recovery it plunged to below $1.27 – its lowest level since 1985 – on October 5, after prime minster Theresa May signalled her intent to formally begin the process of leaving the trade bloc in March 2017.

Japanese easing

Another dovish central bank is the Bank of Japan (BoJ), which Nelson says could take further easing steps given subdued growth and inflation trends in Japan.

"That said, easing measures from the BoJ have been somewhat tentative this year, and we are becoming less convinced that recent actions and subsequent measures will be effective in reflating Japan's economy," Nelson adds.

Dovish Swiss

The Swiss National Bank (SNB) is also likely to maintain its dovish stance for some time, especially as inflationary pressures remain broadly absent from the economy and underlying domestic demand is soft.

"Meanwhile, SNB policymakers continue to express concern about excessive strength in the Swiss franc, while there have been signs of foreign exchange intervention to restrain the franc. In that regard, SNB policy may depend, to an extent, on expected or actual action from the [European Central Bank], particularly as it concerns the exchange rate," he says.

As for the ECB, Nelson says: "We see risks skewed toward further easing going forward. Inflation remains well below the ECB's 2% target and economic growth is tepid. That said, future monetary policy actions may be more gradual, and could include an extension of the asset purchase programme beyond March 2017 or operational tweaks to the asset purchase programme rather than wholesale cuts to its policy interest rates."