FRANKFURT: The European Central Bank (ECB) has a problem, and, no, it is not the exchange rate.
The recent appreciation of the euro may have caught all the headlines, but it pales in comparison with the broader challenge the pandemic poses for monetary policy.
Rather than simply talking down the currency, the ECB must take more substantive steps to support economic growth and lift inflation back to target.
Since the start of the summer, the euro has soared to nearly US$1.20, its highest level in more than two years. A stronger currency can damage growth, since it makes eurozone exports more expensive relative to other foreign goods. It also lowers import prices, pushing down the inflation rate.
Last Thursday, ECB President Christine Lagarde presented the bank’s new set of forecasts and explained that the stronger euro was one reason why inflation was expected to stay underneath the central bank’s target of “below but close to 2%” in the coming years.
The ECB’s governing council mentioned the euro in the introductory statement that accompanied Lagarde’s press conference, but the president took some heat for not reassuring currency traders that the ECB would intervene if the euro did not pare its gains or, worse, continued to soar.
The exchange rate against the dollar climbed throughout the day, causing some embarrassment.
And yet, keeping mum about the euro was undoubtedly the right approach.
As Lagarde mentioned, the ECB does not set a target for the exchange rate but includes the strength of the currency in its analysis of inflation.
The world’s leading central bankers have long avoided explicitly referencing the need for a depreciation of their own currency for fear of sparking retribution from other countries. A full blown “currency war” would destabilise the global monetary system to the detriment of all.
Additionally, a strong euro is far from being the most dangerous threat to Europe’s economic recovery. More alarming is the resurgence of the virus on the continent and the risk that it will require more draconian social-distancing measures.
This will have an effect on how fast business and consumer confidence will return. The central bank must also consider the effectiveness of fiscal plans that governments will unveil in the autumn.
Even if one were to concentrate solely on the eurozone’s ability to export, the strength of overseas demand and the state of global trade will be more important than the future path of the exchange rate.
This is not to say that the ECB should be relaxed about the outlook. Lagarde was cautious but optimistic in her press conference, noting “a strong rebound in activity.”
In a blog post on Friday, ECB chief economist Philip Lane was more wary, as he left the door open for a new round of stimulus. However, given the central bank’s admission it will fail to hit its inflation target by 2022, one wonders why it hasn’t already announced a fresh set of measures.
The ECB probably wants to see more solid evidence of what is happening to the economy, and the coming weeks will provide better data to assess it. — Bloomberg
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