FED UPS EURO STAKES FOR ECB / THE WALL STREET JOURNAL

Fed Ups Euro Stakes for ECB

By Richard Barley

April 10, 2014 1:34 p.m. ET


What the Fed giveth, the Fed can also taketh away—at least as far as the euro is concerned. That won't be welcome news for the European Central Bank.

The euro on Thursday returned to near its 2014 high against the U.S. dollar after a dovish set of minutes from the U.S. Federal Open Market Committee. At $1.387, it has now reversed much of its move lower since March 19, when Federal Reserve Chairwoman Janet Yellen said a rate hike might come six months after the U.S. central bank finally winds down its bond-purchase program.

Investors interpreted Ms. Yellen's March comments as signaling policy tightening could come in mid-2015, boosting the allure of the dollar. But the latest minutes seemed to show that the Fed hadn't changed its stance as much as thought. That led U.S. short-term interest rates to fall, and the dollar to lose its shine.

The Fed's tone is a setback for the ECB, where extremely low inflation— which hit just 0.5% in March—has put an intense focus on the strength of the euro. The ECB is facing calls to ease policy, but so far has stuck with seeking to beef up its guidance that rates will stay low for an extended period, or move even lower.

The ECB can claim some success for its policy of verbal guidance. Very-short-term interest-rate contracts are pricing in a meaningful chance that the ECB will act in some way: the Euro Overnight Index Average—the key short-term euro-zone rate—is priced at 0.12% in November, down from around 0.2% now, analysts at Barclays note. But the euro, propped up by the euro zone's current-account surplus and continued flows into European markets, has proved relatively immune to the ECB's talk of looser policy.

Ultimately, however, markets should recognize that the ECB will be a long way behind the Fed in tightening policy; the euro should decline in time. The ECB forecasts that inflation will only return slowly to target, reaching 1.7% in the fourth quarter of 2016, and J.P. Morgan thinks the ECB rate might still be at 0.25% in 2018.

But if the Fed persists in talking dovishly even as the U.S. economy picks up the pace, then the ECB's exchange-rate discomfort may last for some time yet.