Mario Draghi may find a falling currency can’t buy much of an economic recovery.
The euro has dropped toward a two-year low against the dollar since the European Central Bank president boosted stimulus earlier this month. Economics textbooks say that should lift Europe’s struggling growth rate by boosting exports and speed inflation by raising import prices. Such effects will be more welcome if falling commodities deal a disinflationary blow.
It’s time for those textbooks to be revised, according to economists at Societe Generale SA led by Michala Marcussen, who reckon a devaluation of the euro will not be as stimulatory as it once was and perhaps as much as the ECB is hoping.
For one thing, the single currency may not be that weak yet. While it has fallen 7.5 percent against the dollar this year, it has slipped just 4 percent on a trade-weighted basis.
A deep decline may be hard to achieve. While the euro should keep falling against the dollar and sterling as the Federal Reserve and Bank of England shift toward higher interest rates, those currencies account for only about a third of the trade-weighted index.
The monetary policies of Japan and China are almost just as important, with the yen and yuan accounting for a quarter of the euro’s value, according to Marcussen. With their central banks also dovish, the euro may have less far to fall against those currencies, meaning a 10 percent decline on a trade-weighted basis would require the single currency to drop below $1.15 and 70 pence. It was at $1.28 and 0.78 pence today.
Another brake on any descent is that the euro’s long-term rate may actually have risen since the global financial crisis to $1.35 from $1.31, Societe Generale calculates. That’s because in aggregate the euro area is running a current-account surplus and its budget deficit and debt are lower than in other major economies.
Even if the euro does hit the skids, changes to how economies operate mean it is less of a growth driver than it once was, according to Marcussen.
Reason one is that a weaker currency comes with lower borrowing costs, and while this should be good news, she worries that households, especially those in Germany, regard lower rates as a reason to save, not spend, to meet future needs.
The ability of Chinese factories to keep churning out low-cost goods also limits the chances of euro-area companies winning market share through price competition. Wages might not shift higher with inflation, so higher import costs end up eroding consumer purchasing power and weighing on prices.
Effects across the 18-nation region will also differ. A 10 percent drop in the euro may increase aggregate exports by 2.5 percent, but only by 1 percent in Germany and as much as 5 percent in France. Such a gap explains why French policy makers are more vocal on exchange-rate matters than Germans.
For Draghi, a lesson could be learned by looking at Bank of Japan Governor Haruhiko Kuroda. Although a falling yen on his watch initially bolstered growth and inflation in Japan, exports fell in August and the inflationary impact of rising import costs may be easing.
“It’s also worth recalling that a weaker euro is not a solution to structural rigidities,” said Marcussen. “Countries that have in the past relied excessively on exchange-rate depreciation as a policy tool have generally done so at their peril.”