Fear of euro gains may ham­per ECB’s rate-hike mo­men­tum


For all the Euro­pean Cen­tral Bank’s sig­nal­ing of an in­ter­e­strate “lift-off’’ next year, it might not get very far off the ground.

Some in­vestors sus­pect even mod­estly higher bor­row­ing costs will un­leash a rally in the euro that un­der­mines eco­nomic growth and curbs in­fla­tion. That could leave the cur­rency bloc trapped with near-zero rates for years to come. Spillovers from a po­ten­tial slow­down in the US, the world’s largest econ­omy, may also weigh on the ECB’s scope to tighten pol­icy.

The dilemma for cen­tral bankers is that the euro zone’s fo­cus on ex­ports and re­trench­ment in spend­ing since the dou­ble-dip re­ces­sion means that the bloc is now run­ning a large cur­rent-ac­count sur­plus. That puts up­ward pres­sure on the ex­change rate, so far coun­tered by the ECB’s ul­traloose mon­e­tary stance.

“It high­lights that the ECB’s job is im­pos­si­ble,” said James Athey, a money man­ager at Aberdeen Stan­dard In­vest­ments, who says the in­sti­tu­tion may not even be able to raise the de­posit rate above zero, from mi­nus 0.4 per­cent cur­rently. “It’s go­ing to be dif­fi­cult to care­fully tighten fi­nan­cial con­di­tions with­out an ac­ci­dent.”

Back in 2014, when the sin­gle cur­rency was flirt­ing with $1.40, the ECB cut the de­posit rate be­low zero and laid the ground for an as­set-pur­chase pro­gram that will reach ^2.6 tril­lion ($3 tril­lion) by De­cem­ber. The euro al­most plunged to par­ity with the dol­lar be­fore slowly pick­ing up as the econ­omy re­cov­ered, and even those gains prompted some pol­icy mak­ers to ex­press con­cern as it climbed to al­most $1.26 ear­lier this year. It’s now around $1.16.

Ex­port sen­si­tiv­ity rate strength­ens too much, it will dis­rupt trade,” said Richard Ford, head of Euro­pean fixed in­come at Mor­gan Stan­ley In­vest­ment Man­age­ment. “If your base case is that the euro is go­ing to rally above $1.25, then Europe may have some chal­lenges.”

The cen­tral bank is al­ready strug­gling to re­vive con­sumer prices. In­fla­tion data pub­lished Fri­day showed the core rate un­ex­pect­edly slow­ing to just 0.9 per­cent. The head­line rate was boosted by en­ergy costs.

A coun­ter­ar­gu­ment, for ex­am­ple by Clau­dio Bo­rio, the head of the Bank for In­ter­na­tional Set­tle­ments’ eco­nom­ics de­part­ment, is that cen­tral banks need to ac­cept that re­vers­ing crisis- era mon­e­tary pol­icy will be bumpy and just get on with it. The BIS warned in Septem­ber that years of low in­ter­est rates have spawned a surge in zom­bie firms that are weigh­ing down pro­duc­tiv­ity.

Even the ECB’s Praet has ac­knowl­edged that keep­ing rates low for a long time can lead to a buildup of fi­nan­cial­sta­bil­ity risks such as overex­tended home prices.

“It may be the case that go­ing to a more nor­mal state is ben­e­fi­cial,” said Bob Michele, chief in­vest­ment of­fi­cer and global head of fixed in­come at JP­Mor­gan As­set Man­age­ment. “The risk in Europe is en­trench­ing a dis­in­fla­tion­ary mind­set by not act­ing.”

Still, a re­port pub­lished by re­searchers at Italy’s cen­tral bank this week pointed to the ex­change rate as hav­ing a “rel­a­tively high” im­pact on the cur­rency bloc’s in­fla­tion trend, and sug­gested that it will be a “chal­lenge” to nor­malise pol­icy while en­sur­ing suf­fi­ciently sup­port­ive fi­nan­cial con­di­tions.

Schroder In­vest­ment Man­age­ment sees par­al­lels with the Bank of Japan, which has been pump­ing stim­u­lus into the Asian na­tion for years in an ef­fort to re­vive con­sumer prices and keep the yen in check.

“In a per­fect world, euro-zone re­cov­ery would be ac­com­pa­nied by higher in­ter­est rates and a sta­ble cur­rency,” said Keith Wade, the chief econ­o­mist.

“There is a dan­ger that, like Japan be­fore it, an­other econ­omy with a cur­rent-ac­count sur­plus and in­abil­ity to cre­ate in­fla­tion, the euro zone will find it­self stuck with a very loose mon­e­tary pol­icy for an in­def­i­nite pe­riod.”


Euro­pean Cen­tral Bank pres­i­dent Mario Draghi

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