Markets Insight
January 22, 2013 2:16 pm
ECB missing in action in the currency war
Euro’s strength threatens to strangle export growth
Who would have thought six months ago that in early 2013 the euro would rank among the world’s strongest-looking currencies?
Europe’s single currency has risen almost 7 per cent on a trade-weighted basis since late July. It is up about 25 per cent against the yen and 10 per cent against the dollar.
The currency’s strength follows European Central Bank action to remove the risk of a eurozone break-up. It also reflects global economic power playing – or what Jens Weidmann, Bundesbank president, warned on Monday was the “increased politicisation” of exchange rates.
Mr Weidmann meant Japan, which on Tuesday starting pushing more aggressively for an inflationary stimulus. But the US remains bent on quantitative easing, while sterling’s weakness has been semi-officially endorsed in the UK (the eurozone’s most important export destination) and encouraged by talk of exiting the European Union.
If a covert currency war is under way, the ECB is missing in action – which raises questions about the central bank’s level of concern.
One might even have the impression the ECB was not bothered. At the end of last year, Mario Draghi, ECB president, appeared to be trying to talk the currency down, letting slip that a further loosening of eurozone monetary policy had been actively discussed at December’s meeting and striking a gloomy tone on eurozone economic prospects.
By earlier this month, however – perhaps dizzied by the striking revival in market sentiment towards the euro – Mr Draghi struck a more hawkish tone, insisting that at January’s meeting an interest rate cut was not even discussed.
Asked specifically about the euro’s rise, Mr Draghi said its value was important when the ECB was assessing the economic outlook but “it is not a policy target”. Then he shuffled his papers to find the latest statement on currencies by the G20 group of leading world economies warning against competitive devaluations. In doing so he was following the practice of Jean-Claude Trichet, his predecessor, who was a stickler for institutional process (as is the Bundesbank’s Mr Weidmann).
Finally, Mr Draghi pointed out that in fact the euro’s effective exchange rate remained in line with its long-term average, which added to the impression he saw little need for immediate concern.
It is true that the euro’s trade-weighted value remains significantly lower than in November 2004 and November 2007 when Mr Trichet deployed verbal intervention – or “open mouth operations” – to check the euro’s rise.
On both occasions he warned against “brutal” exchange rate movements, albeit with little success. For some conservative eurozone policymakers, the euro’s rise is perhaps a welcome sign of returning confidence in Europe’s monetary union.
But currency virility can be overdone. Even if the exchange rate is in line with its long time average, these remain exceptional times, especially in the weaker eurozone periphery economies. The eurozone unemployment rate is almost 12 per cent (compared with around 8 per cent in the US) and the ECB is forecasting the region’s economy will contract again this year.
A stronger euro threatens to strangle one remaining source of growth: net exports have contributed positively to eurozone gross domestic product in each of the past 10 quarters, according to Barclays.
Even Germany’s resilient exporters have reason to worry – the euro/yen rate matters for the country’s powerful car manufacturers. Jean-Claude Juncker, Luxembourg’s prime minister, who has just relinquished his chairmanship of eurozone finance ministers meetings, warned last week that the euro’s level was “dangerously high”.
All of which means Mr Draghi needs a contingency plan up his sleeve. A first step could be Trichet-style “open mouth operations”. But the ECB could go further and offer more long-term liquidity, for instance, or lower interest rates further. The latter would not be an easy step. What would matter is not the main interest rate set for banks borrowing its liquidity, currently 0.75 per cent, but short-term market interest rates. These have fallen to the level of the ECB’s deposit rate, paid on overnight deposits, which is currently zero.
So ECB action to halt the euro’s rise might require moving into the uncharted territory of negative interest rates – charging banks for the pleasure of parking funds.
.
Yet Mr Draghi last year proved he can act radically when demanded by circumstances. His pledge to do “whatever it takes” to preserve the eurozone’s integrity was a financial markets game changer. In an uncertain world, his instinct is not to rule out any option.
.
Ralph Atkins is the FT’s Capital Markets Editor
.
Europe’s single currency has risen almost 7 per cent on a trade-weighted basis since late July. It is up about 25 per cent against the yen and 10 per cent against the dollar.
The currency’s strength follows European Central Bank action to remove the risk of a eurozone break-up. It also reflects global economic power playing – or what Jens Weidmann, Bundesbank president, warned on Monday was the “increased politicisation” of exchange rates.
Mr Weidmann meant Japan, which on Tuesday starting pushing more aggressively for an inflationary stimulus. But the US remains bent on quantitative easing, while sterling’s weakness has been semi-officially endorsed in the UK (the eurozone’s most important export destination) and encouraged by talk of exiting the European Union.
If a covert currency war is under way, the ECB is missing in action – which raises questions about the central bank’s level of concern.
One might even have the impression the ECB was not bothered. At the end of last year, Mario Draghi, ECB president, appeared to be trying to talk the currency down, letting slip that a further loosening of eurozone monetary policy had been actively discussed at December’s meeting and striking a gloomy tone on eurozone economic prospects.
By earlier this month, however – perhaps dizzied by the striking revival in market sentiment towards the euro – Mr Draghi struck a more hawkish tone, insisting that at January’s meeting an interest rate cut was not even discussed.
Asked specifically about the euro’s rise, Mr Draghi said its value was important when the ECB was assessing the economic outlook but “it is not a policy target”. Then he shuffled his papers to find the latest statement on currencies by the G20 group of leading world economies warning against competitive devaluations. In doing so he was following the practice of Jean-Claude Trichet, his predecessor, who was a stickler for institutional process (as is the Bundesbank’s Mr Weidmann).
Finally, Mr Draghi pointed out that in fact the euro’s effective exchange rate remained in line with its long-term average, which added to the impression he saw little need for immediate concern.
It is true that the euro’s trade-weighted value remains significantly lower than in November 2004 and November 2007 when Mr Trichet deployed verbal intervention – or “open mouth operations” – to check the euro’s rise.
On both occasions he warned against “brutal” exchange rate movements, albeit with little success. For some conservative eurozone policymakers, the euro’s rise is perhaps a welcome sign of returning confidence in Europe’s monetary union.
But currency virility can be overdone. Even if the exchange rate is in line with its long time average, these remain exceptional times, especially in the weaker eurozone periphery economies. The eurozone unemployment rate is almost 12 per cent (compared with around 8 per cent in the US) and the ECB is forecasting the region’s economy will contract again this year.
A stronger euro threatens to strangle one remaining source of growth: net exports have contributed positively to eurozone gross domestic product in each of the past 10 quarters, according to Barclays.
Even Germany’s resilient exporters have reason to worry – the euro/yen rate matters for the country’s powerful car manufacturers. Jean-Claude Juncker, Luxembourg’s prime minister, who has just relinquished his chairmanship of eurozone finance ministers meetings, warned last week that the euro’s level was “dangerously high”.
All of which means Mr Draghi needs a contingency plan up his sleeve. A first step could be Trichet-style “open mouth operations”. But the ECB could go further and offer more long-term liquidity, for instance, or lower interest rates further. The latter would not be an easy step. What would matter is not the main interest rate set for banks borrowing its liquidity, currently 0.75 per cent, but short-term market interest rates. These have fallen to the level of the ECB’s deposit rate, paid on overnight deposits, which is currently zero.
So ECB action to halt the euro’s rise might require moving into the uncharted territory of negative interest rates – charging banks for the pleasure of parking funds.
.
Yet Mr Draghi last year proved he can act radically when demanded by circumstances. His pledge to do “whatever it takes” to preserve the eurozone’s integrity was a financial markets game changer. In an uncertain world, his instinct is not to rule out any option.
.
Ralph Atkins is the FT’s Capital Markets Editor
.
Copyright The Financial Times Limited 2013
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