At a three-year high, euro faces ECB scrutiny
BRUSSELS (Reuters) – After hitting a three-year high against the dollar, the strong euro is likely to preoccupy global markets and European Central Bank policy makers in particular this week.
The ECB, whose Governing Council meets on Thursday, last expressed concern over the single currency in September, when it said exchange-rate volatility was an uncertainty that required “monitoring.” Then the euro had only briefly nudged beyond $1.20. Over the past week it has surpassed $1.23 and is now some 4% higher than when ECB policy makers met in December, although on a trade-weighted basis the euro’s rise is not as steep.
Its January surge followed the release of minutes from the December ECB meeting, which showed the bank intended to revisit its policy message in early 2018, prompting markets to price in a 70% chance of a rise in interest rates by the end of the year. The ECB last hiked rates in 2011.
Reuters reported last Wednesday that the ECB was unlikely to ditch its pledge to keep buying bonds at its January meeting.
Public comments over the past week show its policy makers are growing more alert to the euro’s strength. ECB Vice President Vitor Constancio said the ECB did not have an exchangerate target, but he was concerned by sudden movements that did not reflect changes in fundamentals.
Austrian Central Bank President Ewald Nowotny said the euro’s gains against the dollar “not helpful.”
PAIN THRESHOLD
European firms used to express more concern about the euro crossing what they called the pain threshold, curbing exports and therefore overall growth. The euro-zone economy is currently motoring along at a decade-high pace of 2.5% per year.
The impact of a strong euro on growth has steadily faded, said Carsten Brzeski, a Frankfurt-based economist for ING, as an increasing number of invoices are denominated in euros, and companies are more active hedging their currency exposure.
“This time it matters more for inflation than for growth,” he said.
Sustained euro strength, Brzeski said, would reduce the ECB’s inflation assumptions this year and next – 1.4% and 1.5%, respectively – by 0.2 percentage point. This would move them further from the ECB target of close to but below 2% and reduce the prospects of an early and sudden end to quantitative easing.
The euro might not have hit a pain threshold yet, but ECB policy makers will not want to encourage any further rise
Indeed, the most recent euro-zone inflation figures vindicate the ECB’s easy-policy stance. The rate in December fell to 1.4% from 1.5% in November, and underlying inflation, excluding volatile energy, food, alcohol and tobacco, was a mere 0.9% for the third month in a row.
The euro might not have hit a pain threshold yet, but ECB policy makers will not want to encourage any further rise.
Nordea Markets economist Jan von Gerich suggested that ECB President Mario Draghi will sound a shade less optimistic than in December to convince markets that the next rate hike is not coming sooner and to stop the euro from rising further.
“We expect to see some downside pressure on the euro and bond yields in response to the ECB’s immediate message next week,” he said in a note on Thursday.
‘AMERICA FIRST’
The Bank of Japan, with a two-day meeting that ends on Tuesday, is also seen putting its policy on hold, including a pledge to keep short-term interest rates at minus-0.1%, while painting a slightly better picture of the economy.
In the United States, whose Federal Reserve meets at the very end of January, data should show an economy racing on, with its annualized growth forecast to be at least 3% for the third consecutive quarter in the October-December period.
Consumer spending has been strong and business investment solid.
US President Donald Trump may see such a rate as confirmation that he is making America great again.
UniCredit chief US economist Harm Bandholz tempered the optimism, saying a range of factors, including inventories, trade, oil and the savings rate, are providing temporary boosts and will fade.
Without a planned tax cut, another temporary boost, growth would fall back to 2%-2.5% by mid-2018 toward potential US growth of 1.5%-2%, he said.
On the trade front, this week may also see more signals about Trump’s “America First” stance.
US, Canadian and Mexican negotiators will convene in Montreal from Tuesday in talks to update the North American Free Trade Agreement.
Prospects for the talks are unclear. Trump told Reuters last Wednesday that terminating NAFTA would result in the “best deal” to revamp the pact, which he blames for Mexico’s large trade surplus with the United States. Economists polled by Reuters, however, broadly expect NAFTA to be renegotiated with only minor changes.
The week will close with the president himself delivering a highly anticipated speech on last day of the World Economic Forum at Davos in the Swiss Alps.