LONDON (Reuters) - How concerned should policymakers be by the euro’s rapid rise to 28-month highs? Those tracking the currency’s effects on growth, inflation and exports reckon it’s still some way off levels that would start to dent economic recovery.
Since mid-May, the currency has risen nearly 10%versus the dollar and futures markets show it has drawn a record number of bullish bets.
On a trade-weighted basis, the gauge watched by the European Central Bank, the euro is up nearly 5%.
That pace of gains was last seen in mid-2017, a time of optimism about economic growth - in marked contrast to the current appreciation that coincides with the deflationary and recessionary impact of a pandemic.
As inflation turned negative in August for the first time since 2016, some economists placed the blame on the euro and piled on the pressure for the ECB to act
ECB chief economist Philip Lane delivered the first salvo, saying the exchange rate “does matter” for monetary policy, while the Financial Times quoted unnamed ECB sources as saying euro strength was concerning.
Yet it may be premature for the ECB to announce any steps at its Sept. 10 meeting.
Euro strength stems not solely from U.S. assets’ vanishing interest rate advantage over Europe, but from improved sentiment towards Europe’s proactive response to COVID-19 that included a 750 billion-euro ($886.28 billion) fund seeded by joint debt sales.
ECB board member Isabel Schnabel told Reuters she was “not worrying too much about exchange rate developments,” as a weak dollar usually lifts global trade and growth, offsetting the euro effect for local firms.
Nomura analyst Jordan Rochester agreed and said the euro was up for “good reasons”.
“A strong currency due to positive macro fundamentals is not that much of a bad thing for policymakers and its inflation impact is temporary in nature,” he said.
A cut to Germany’s value-added tax may have hit August prices, which was predicted by the ECB, according to minutes of its July meeting, he added.
ECB to rein in euro?
LEVEL TO WATCH IS 10% YEAR-ON-YEAR
The ECB still has no room for complacency.
In common with other central banks, it may be forced to rethink longer-term monetary policy given the U.S. Federal Reserve’s landmark shift to a more tolerant inflation stance, which could weaken the dollar for years.
But as of now, the euro’s rise should not inflict major damage. At current levels, the trade-weighted euro would take 0.1-0.2 percentage point off ECB inflation projections in the coming year, ABN Amro strategist Nick Kounis estimated.
This is bad news in a deflationary environment, but “not the end of the world,” Kounis said.
Another 3%-4% rise in the trade-weighted rate was, he said, “where (the ECB) would be thinking not only about what strategy to use to boost inflation but also specific measures to target the euro.”
For many, the level to watch is a year-on-year 10% appreciation. From current levels that would take the euro near $1.30. A 10% gain is also the level analysts say would knock 0.4% off the euro zone’s annual economic growth and around 6% of earnings-per-share at regional firms.
Dhaval Joshi, investment strategist at BCA Research cited past ECB claims that a 10% euro rise shaves 0.4-0.5 percentage point from inflation.
Euro during the coronavirus crisis
“I think the ECB are watching the rate of appreciation of the euro with perhaps 10% year-on-year as a point of concern...another 2.5% appreciation would be a trigger point to act in my view,” Joshi said.
A further consideration is that, even after its rally, the euro is not expensive and sits in the middle of its two-decade trading range of $0.80-$1.60.
Adjusted for inflation differentials against its peers such as dollar, sterling and yen, the euro is 5% below its long-term average, Nomura’s Rochester says.
Reporting by Olga Cotaga; Additional reporting by Dhara Ranasinghe and Thyagaraju Adinarayan; Editing by Saikat Chatterjee, Sujata Rao and Barbara Lewis
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