• English Site
• >Business
• >

  The Euro's Rise: Don't Expect a Rate Cut

The Euro's Rise Don't Expect a Rate Cut

By Natascha Gewaltig

Part 2: The ECB's Choices

To the extent that the stronger euro helps with the medium-term inflation outlook, it also affects ECB policy. By the EU's reckoning, a 6 percent appreciation of the real trade-weighted index has the same economic effect as a 100 basis point interest-rate hike. The 14 percent rise in the trade-weighted index since the ECB's last rate hike has acted as an additional tightening of monetary conditions in the absence of policy moves by the central bank.

Before the subprime crisis, the ECB clearly would have preferred tightening via interest rates rather than going the exchange rate route through further appreciation of the euro. However, in the current situation of fragile growth and increased economic uncertainty, a rate hike would be very difficult to sell to the markets and could further weigh on optimism about growth. So the ECB's hawks, who are still worried about inflation, may welcome some tightening of monetary conditions through an increasingly robust euro. This may help explain why ECB officials have so far remained relatively calm regarding the euro's strength.

Nevertheless, concern is creeping in, and with the euro appreciating further against the dollar support may build for the notion that the ECB's interest rate policy is partly to blame for the strength of the single currency. What options does the central bank have to stem the euro's rise?

Avoiding "Volatility"

It could intervene directly on foreign exchange markets. Currency management in the euro zone is split between politicians, who can issue general guidelines or enter global currency agreements, and officials at the ECB, who are in charge of day-to-day management and interventions. Former ECB President Wim Duisenberg famously called himself "Mr. Euro" and President Jean-Claude Trichet has also stressed that he has the last word on exchange rates. The ECB doesn't seem to be considering such an option.

In any case, it's clear that unilateral intervention has little chance of success, and even coordinated intervention is problematic. The choices that remain are verbal intervention and exercises in damage limitation. Officials have started to repeat the familiar G7 line that "excess volatility" in exchange markets is undesirable and that exchange rates should reflect fundamentals.

President Trichet said recently that the ECB is concerned "about excessive exchange rate moves in the present circumstances," adding that he has "noted with extreme attention the statement of US authorities reaffirming that the strong dollar is in the interest of the US economy." What Trichet and other euro zone officials will likely want to see is a public message to markets that the US is interested in a strong currency and will not passively encourage an ongoing rapid depreciation of the dollar.

For reasons of data protection and privacy, your IP address will only be stored if you are a registered user of Facebook and you are currently logged in to the service. For more detailed information, please click on the "i" symbol.

Post to other social networks:

• 
• 
• 
• 
• 
• 
• 
• 
•