The euro is at two-and-a-half-year highs. Its strength risks driving ultra-low inflation even lower. The European Central Bank may be squeamish about blatantly targeting a weaker euro. But it need have no qualms about picking monetary policy tools that maximise damage to the single currency.
The euro has climbed 11 percent in trade-weighted terms since July 2012, when ECB President Mario Draghi stood up for the single currency. Initially, its gains were hailed as a vote of confidence. Now, they look like too much of a good thing.
Draghi reckons the euro’s rise has lopped 0.4 percentage point off inflation. It also hurts GDP growth by eroding exporters’ competitiveness. That’s unhelpful: euro zone inflation is less than half the ECB’s target and growth is still fragile.
The central bank generally avoids talking about exchange rates, not least because they are only one of many factors that influence policy.
But discontent is surfacing. On March 10, Bank of France Governor Christian Noyer – generally on-message rather than a maverick – expressed unhappiness about the euro’s strength. Yet it rose further. By contrast, Bank of England Deputy Governor Charlie Bean weakened sterling on the same day by saying any further strength could delay a UK rate rise.
Further euro gains may provoke stronger rhetoric. But if the ECB really wants to halt the move, it will have to do more. It could follow Bean’s example and announce a firmer tie between the currency and monetary policy. But that may be too explicit for the central bank.
A more acceptable approach might be to loosen policy in a way that inflicts the most damage on the currency – by a happy coincidence. That tactic has been tried and tested by the Bank of Japan. A further rate cut, including a sub-zero deposit rate, might do the trick. Full blown quantitative easing entails thorny problems but would also work. Boosting lending to small- and medium-sized firms won’t.
The strong euro is compounding the ECB’s low-inflation headache. The central bank’s reluctance to join global currency wars may be laudable but looks less and less tenable.