The European Central Bank said the strength of the euro is threatening to damp inflation, suggesting policy makers may be open to cutting interest rates if the currency appreciates further.
While “risks to the outlook for price developments continue to be seen as broadly balanced over the medium term,” downside risks relate to “weaker economic activity and, more recently, the appreciation of the euro exchange rate,” the Frankfurt-based ECB said in its monthly bulletin today, echoing President Mario Draghi’s Feb. 7 policy statement.
While latest data show the 17-nation euro economy is starting to stabilize after the sovereign debt crisis drove it into recession last year, the euro’s gains could stymie a recovery before it has begun by curbing exports and pushing inflation too low. Eurostat, the region’s statistics office in Luxembourg, will report gross-domestic-product data for the fourth quarter at 11 a.m. today, and the ECB is set to publish new economic projections next month.
Draghi indicated last week that policy makers are concerned about the strength of the euro, which has appreciated 9 percent against the dollar since late July, when he pledged to do whatever it takes to protect the single currency.
“The exchange rate is not a policy target, but it is important for growth and price stability,” Draghi said after the ECB kept its benchmark rate at a record low of 0.75 percent. “We want to see if the appreciation is sustained, and if it alters our assessment of the risks to price stability.”
The ECB noted in today’s bulletin that the euro gained 3.3 percent against the currencies of its 20 biggest trading partners in the first month of this year. Against the yen, it was up 11.3 percent, the ECB said. The single currency fell 0.4 percent today to $1.3393.
Professional forecasters surveyed by the ECB cut their estimates for growth and inflation in the euro area for this year and next.
Forecasters predict inflation of 1.8 percent in 2013 and 2014, down from the 1.9 percent estimated for both years three months ago, the ECB said, citing its quarterly survey. Forecasters foresee zero growth this year and expansion of 1.1 percent next year, less than the previous estimates for 0.3 percent and 1.3 percent growth, it said.
The ECB currently predicts inflation will average 1.6 percent this year and 1.4 percent in 2014. It aims to keep the rate just below 2 percent. In December the ECB forecast the economy will contract 0.3 percent in 2013 before growing 1.2 percent in 2014.
“The economic weakness in the euro area is expected to prevail in the early part of 2013,” the ECB said today. “Later in 2013 economic activity should gradually recover, supported by our accommodative monetary policy stance, the improvement in financial market confidence and reduced fragmentation, as well as a strengthening of global demand.”