Why bank profits matter for FX? There are two main reasons why bank profitability should matter for an FX investor.
expected returns could cause banks to start to lend outside their own
region, which would weaken the domestic currency as the money borrowed
from the local central bank is swapped into a foreign currency.
healthy banking sector should promote local risk taking, which if feeds
through into higher inflation, would normally strengthen a currency.
EUR higher from bank repatriation.
The Eurozone is a great example of where declining bank returns have affected the currency. The
ECB cutting interest rates to 0.05% at the end of 2014 caused Eurozone
bank activity to pick up significantly since the banks could fund
themselves at even lower rates.
Eurozone bank foreign lending books picked up, growing at their peak
at 15%YoY in April 2015 (Exhibit 8), a process that helped the EUR to
weaken. There were two periods that followed. Firstly, the EUR stopped
weakening as Eurozone bank foreign loan growth started to contract due
to little demand. Secondly,and a process that is still occurring, low
bank returns and generally weak balance sheets caused these Eurozone
banks to close out of their foreign loan books, repatriating the
proceeds and thus supported the EUR.
Going forward if bank profitability stays low then we are likely to see further repatriation, adding to our bullish EUR view.