European Central Bank President Mario Draghi has found his most effective weapon is the sound of his own voice.
Draghi yesterday caused the euro’s biggest drop in seven months by suggesting its recent appreciation could damp inflation, a signal that further interest-rate cuts remain a possibility. His pledge in July to buy government bonds precipitated a sea-change in sentiment that helped to shore up the 17-nation euro economy, yet the ECB hasn’t spent a cent so far in its so-called Outright Monetary Transactions program.
The ECB “is becoming a master of verbal intervention,” Danske Bank economists wrote in a research note. Draghi yesterday “managed to dampen recent de facto tightening without taking any action, much as was the case with the OMT program, which has so far managed to lower Spanish and Italian bond yields without buying a single bond,” they said.
Draghi’s oratory is helping the ECB navigate a path out of the sovereign-debt crisis for the economy, whose recovery from recession is being threatened by the stronger euro. The risk is he may eventually be forced to follow through on his promises and ramp up stimulus as looser monetary policies by the Federal Reserve and Bank of Japan weaken their currencies.
“Exchange-rate comments can be successful for as long as they’re thought to be credible, so long as markets believe the ECB will change policy if the euro gets too strong,” said Chris Scicluna, head of economic research at Daiwa Capital Markets Europe in London and a former U.K. Treasury official. “I’m not overly convinced that the ECB will get to a position where it will think about easing policy to offset the exchange rate.”
The euro fell as low as $1.3371 after Draghi spoke from $1.3547 beforehand and traded at $1.3405 at noon in Frankfurt today. It reached a 14-month high of $1.3711 this month and a three-year high against the yen.
“This was a deft verbal intervention on the part of the ECB president,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy Ltd. in London. “He managed to talk down the euro while talking up the euro zone.”
The ECB left its benchmark rate at a record low of 0.75 percent yesterday. While Draghi said the ECB’s low rates would fuel an economic recovery later this year, he suggested the euro’s appreciation could push inflation further below the central bank’s 2 percent limit than it currently forecasts.
“The exchange rate is not a policy target, but it is important for growth and price stability,” Draghi said at a press conference in Frankfurt. “We want to see if the appreciation is sustained, and if it alters our assessment of the risks to price stability.”
Draghi was speaking at the same time as Bank of England Governor-designate Mark Carney was advocating the importance of communication in monetary policy to lawmakers in London. The U.K. central bank yesterday kept its target for bond purchases at 375 billion pounds ($591 billion) and left the key rate at a record low of 0.5 percent.
While the latest data show the euro-area economy is starting to stabilize, the currency’s gains could stymie a recovery before it has begun by curbing exports.
Exports from Germany, Europe’s largest economy, rose 0.3 percent in December after dropping 2.2 percent in November, the country’s statistics office said today. In France, business confidence rose for a second month in January in a sign that Europe’s second-biggest economy may be improving.
While the ECB president expects a gradual recovery to take hold in the euro area later this year, he said risks to the outlook remain on the downside. The ECB will publish new economic projections next month and officials will “maintain our accommodative monetary stance,” he said.
“He’s signaling that they could respond,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London and a former Bank of England official. “It’s not just words. He said there’s a point at which we will have to respond, and we’re not indifferent to the euro.”
Draghi’s predecessor, Jean-Claude Trichet, also used verbal warnings to influence the euro, speaking of “brutal” shifts in currencies when it got too strong.
Draghi dismissed speculation that central banks are embarking on a “currency war” by trying to boost growth through lower exchange rates. Policies are aimed at domestic conditions and the euro’s value broadly reflects economic fundamentals, he said.
Japan today posted back-to-back monthly current-account deficits for the first time since 1981, highlighting challenges for Prime Minister Shinzo Abe’s campaign to revive the economy. Abe is pushing for the Bank of Japan to end deflation and spur growth, prompting a slide in the yen that may aid an export revival.
If monetary policies produce “consequences on the exchange rate that do not reflect the G-20 consensus, we will have to discuss this,” Draghi said. Central bankers and finance ministers from the Group of 20 nations convene in Moscow next week.
“When it comes to the currency race to the bottom, this is one race the ECB is going to lose,” Andrew Bosomworth, managing director at Pacific Investment Management Co. in Munich, said in an interview with Bloomberg Television today. “One major difference between the euro area and the other major currencies of the world, the dollar, sterling and yen, is that the euro zone is depreciating internally with wages, everybody else is trying to depreciate externally with their exchange rate.”
The initial reaction to Draghi’s comments nevertheless suggests “that the ECB and Draghi have a lot of credibility in the market,” said Nick Matthews, senior euro-area economist at Nomura International Plc in London. “And that’s very important for this kind of attempt to change expectations.”