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Goldman Sachs: Euro to Slide to Parity Against Dollar by End of 2016

The euro is likely to drop to parity with the dollar by the end of 2016 and could fall to 90 cents by the end of the following year, Goldman Sachs Group predicts.

A prolonged drag on growth and competitiveness in the eurozone, coupled with extremely low prices in the region and higher short-term U.S. interest rates, will likely propel the single currency lower against the dollar than previously thought, Goldman Sachs’ Robin Brooks, Fiona Lake and Michael Cahill wrote in a research note.

But a decidedly more “activist” European Central Bank also stands behind the accelerated weakening of the common currency, Mr. Brooks said.

“If the ECB does more easing soon, it shows it’s a central bank that is not sitting on the sidelines, which sends a message to the market for an even lower euro,” Mr. Brooks told The Wall Street Journal. “Clients should then position for a meaningfully weaker euro over the next six to 12 months.”

The euro would need to fall more than 15% from current levels to reach parity with the dollar, a level last seen on Dec. 5, 2002. The euro was sitting above a nine-year-low against the dollar at $ 1.1830 on Friday.

Investors have been betting heavily that the euro would weaken since last summer, when the ECB eased policy to combat stagnant growth and low consumer prices in the eurozone. At the same time, yield-hungry investors have been piling into dollar-denominated assets in the belief that the Federal Reserve would raise interest rates sooner than rival central banks, which would boost the U.S. currency.

Over 2014, the common currency lost almost 12% against the dollar, and it’s continued falling.

Still, the euro’s recent slide has taken many analysts by surprise. A survey of 250 banks and financial institutions by Consensus Economics Inc. last month found they were forecasting the euro to be worth $ 1.19 at the end of 2015. That level was breached early this year.

Strategists at Morgan Stanley said the upcoming elections in Greece were a factor in the recent slide.

“European political risk is back on investors’ minds,” they said.

Goldman Sachs has a long history of predicting the euro would rise against the dollar, Mr. Brooks said. That changed last April, as the bank came to the conclusion that the common currency would start to reflect the region’s expected long-term growth underperformance against the U.S., as well as a persistent cycle of low inflation that the bank now calls the most severe among developed markets.

In August, Goldman Sachs predicted the euro would fall to parity by the end of 2017. But that forecast didn’t take ECB President Mario Draghi’s intentions into account, Mr. Brooks said.

In September, the ECB lowered its deposit rate further, to negative-0.2 percentage point from negative-0.1 percentage point, set in its June meeting. In November, Mr. Draghi also firmed up talk about expanding the central bank’s balance sheet by about €1 trillion to 2012 levels.

Doing so would likely involve a large-scale bond-buying program, also known as quantitative easing. Goldman Sachs’ European chief economist expects the ECB will announce a program to purchase sovereign debt at its Jan. 22 meeting.

“The sovereign QE discussion changed everything,” Mr. Brooks said. “The ECB has come a long way in the last six months.”

Many big fund managers are also betting on further euro weakness.

“Parity to the dollar is not such a distant target,” said Chris Iggo, head of fixed income for Europe and Asia at AXA Investment Management. Mr. Iggo said AXA is betting on the euro to fall further.

The most recent data from the U.S. Futures Trading Commission showed that investors had increased their bets against the euro by $ 800 million between Dec. 23 and Dec. 30.

Paul Lambert, head of currency at Insight Investment, which manages $ 480 billion of assets, said pressure on the euro could intensify as the Fed and the ECB pursue diverging monetary policy. He is betting the euro will fall below $ 1.10 in 2015.

“The Fed is taking its foot off the gas. We are a million miles from that in Europe,” he said. “Euro-dollar parity this year would be a big move. But if you think this is going to be a year of big divergence between the U.S. and Europe, why not?”

— Chiara Albanese contributed to this report.

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