Both the ECB and the Fed have problems. The ECB’s is how to more towards a more normal policy environment, which sees the end of QE and negative rates, without tightening financial conditions too much via surging bond yields and a surging euro. The last few weeks clearly suggest this could be a tough task. But it is a nice problem to have; much better than fighting the risk of deflation which had become the
ECB’s preoccupation in recent years. In coming meetings the ECB will tweak its guidance still further and, at an even later stage, will start to take the first concrete steps towards normalisation, such as ending bond purchases. As the ECB goes through this process the euro is likely to rise and the confidence with which the ECB acts could prove a key determinant of this strength. The Fed’s problem is that some of the relationships that it would expect to prevail at this stage of the economic and monetary cycle are steadfastly refusing to comply. In June the Fed seemed split between those that see the current inflation undershoot as a temporary problem and those that seem to believe that the whole Phillips curve logic might be flawed. On top of this problem the Fed also questioned why financial conditions have not tightened in spite of the increases in policy rates. With the Fed looking shaky and the ECB assured the way seems clear for the euro to appreciate. It might be tough in the short-term to get above the 1.15-1.17 range that has defined the top for the euro in recent years, but this break should come in time.