The euro’s rise is worrying top policymakers at the European Central Bank, who warn that if the currency keeps appreciating it will weigh on exports, drag down prices and intensify pressure for more monetary stimulus.
Several members of the ECB’s governing council told the Financial Times that the euro’s rise against the US dollar and many other currencies risks holding back the eurozone’s economic recovery. The council meets next week to discuss monetary policy.
“In the last few weeks there has been an appreciation of the euro, which is always worrisome when you have weak demand, especially as the euro area is the most open economy in the world and unusually dependent on global demand,” said one council member.
The council member said the US Federal Reserve’s shift last week to a more dovish average inflation target has driven the euro higher against the dollar and added to the pressure on the ECB to respond with its own strategy review, which it aims to finish next year.
“The problem is that the Fed has already decided and so the market may interpret interest rates as being structurally higher in the euro area, which could lead to a further appreciation of the euro,” they said.
The euro rose this week close to all-time highs against a trade-weighted basket of currencies, having gained about 8 per cent since February.
But it fell 0.41 per cent against the dollar on Thursday morning, pulling back further from the $1.20 level it hit earlier this week.
“It is a growing concern, though it is not yet huge, and if the trend continues it will be a concern and we will have to watch it,” said a second council member, adding that the euro’s rise was likely to require the ECB to further cut its inflation forecast next week.
A third ECB council member pointed out that some of the euro’s strength stemmed from positive factors, such as the EU’s recent €750bn recovery fund and the eurozone’s stronger than expected rebound from the coronavirus pandemic.
“What we have seen reflects the positive story . . . but it also reflects the starting point at which the euro was probably undervalued against the dollar,” said the third council member. “It isn’t that concerning today but it could become a problem.”
ECB chief economist Philip Lane said this week that “the euro-dollar rate does matter”, prompting the euro to retreat after briefly rising above $1.20 against the US dollar. “If there are forces moving the euro-dollar rate around, that feeds into our global and European forecasts and that in turn does feed into our monetary policy setting,” Mr Lane said.
Isabel Schnabel, an ECB executive board member, told Reuters this week that a boost to global trade from a weaker dollar could offset a drag on eurozone exports from the stronger euro, adding: “At the moment I am not worrying too much about exchange rate developments.”
The ECB is expected to cut its 2022 inflation forecast next week from 1.3 per cent to 1.2 or 1.1 per cent to reflect the deflationary impact of a stronger euro on the price of imports, said Frederik Ducrozet, strategist at Pictet Wealth Management. “The euro is one driver of low inflation over the coming months,” he said.
Cutting its inflation forecast further below its target of just below 2 per cent will increase the pressure on the ECB to consider upping its stimulus, Mr Ducrozet said, especially after the eurozone slid into deflation for the first time in four years in August. The ECB has consistently undershot that target for more than a decade.
Mr Ducrozet said “the minimum” the ECB could do in response was to signal an increase in the pace of purchases under its €1.35tn emergency bond-buying programme after they slowed over the summer.
“The governing council will see this as an unwelcome development and their concern will be that the upward trend in the euro could continue,” said Nick Kounis, head of macro and financial markets research at ABN Amro. He predicted the ECB would hold fire next week, before increasing its emergency bond-buying programme by an extra €500bn later this year.
Christian Keller, head of economics research at Barclays, said the most effective way to lower the exchange rate for the ECB would be to cut interest rates. But with its deposit rate already at a record low of minus 0.5 per cent, he said: “I don’t think they will want to do that”.