Draghi Counts Cost of Saving Euro as Currency ReboundsStefan Riecher and Jeff Black
Mario Draghi is discovering that confidence in the euro area comes at a cost.
Since the European Central Bank president talked up the economic outlook last month and signaled that the worst of the debt crisis is over, the euro has surged to a 14-month high against the dollar. Banks have fueled the euro’s rally by paying back more emergency loans than forecast, shrinking the ECB’s balance sheet just as the Federal Reserve and the Bank of Japan expand theirs.
That’s threatening to stymie Europe’s recovery before it has begun, highlighting the tightrope Draghi is walking as he seeks to boost confidence without encouraging euphoria. With looser monetary policy in the U.S. and Japan weakening the dollar and the yen, the ECB may soon come under pressure to enter the so-called “currency war” and rein in the euro, economists said.
“The euro-zone economy needs a rising euro like it needs a hole in the head,” said Nick Kounis, head of macro research at ABN Amro in Amsterdam. “If verbal intervention does not stem the euro’s upward trend, the central bank may eventually once again consider rate cuts.”
The ECB will keep its benchmark rate at a record low of 0.75 percent when policy makers meet in Frankfurt today, according to all 60 economists in a Bloomberg News survey. The decision is due at 1.45 p.m. and Draghi holds a press conference 45 minutes later.
He may face questions about Italy’s Banca Monte dei Paschi di Siena SpA, which is engulfed in criminal probes over its use of derivatives to hide losses. Draghi has yet to publicly comment on his role in overseeing Monte Paschi, the world’s oldest bank, when he was governor of the Bank of Italy.
Still, the focus is likely to be on the euro, which hit $1.3711 on Feb. 1, the highest since November 2011. It rose 0.3 percent to $1.3566 at 9:40 a.m. in Frankfurt today. Against the yen, the euro is at the highest level in almost three years.
A stronger currency damps inflation by reducing prices on imported goods and poses a threat to growth by increasing the cost of exports.
“A strong euro has a negative impact on our profit margins and we would definitely benefit from a weaker euro,” Alvaro Paradinas, corporate development director at Tecnocom, Telecomunicaciones & Energia SA, Spain’s second-largest computer-services company, said in an interview yesterday. “About 25 percent of our sales come from outside the euro zone.”
A 10 percent appreciation against a basket of trading partners reduces euro-area gross domestic product by 0.5 percentage point in the first year, according to Elga Bartsch, chief European economist at Morgan Stanley & Co. in London.
The euro has climbed 11 percent on a trade-weighted basis since Draghi pledged on July 26 to do whatever it takes to preserve the monetary union and unveiled an unlimited bond-purchase plan. He spurred gains last month when he spoke of “positive contagion” on financial markets and a return to economic growth later this year.
He may paint a less upbeat picture today.
“We expect the tone of the statement to turn more cautious on the economic outlook and more relaxed on the outlook for inflation, reflecting the recent increase in some money-market rates and the appreciation of the euro,” said Juergen Michels, chief euro-area economist at Citigroup Inc. in London.
The Euro Overnight Index Average, or EONIA, climbed to 0.08 percent from 0.06 percent after banks handed back more of the ECB’s three-year loans than economists expected at the first early-repayment opportunity last month.
As a result, the ECB’s balance sheet shrank to an 11-month low of 2.77 trillion euros ($3.76 trillion) last week from a record-high of 3.1 trillion euros at the end of June.
That contrasts with the Fed’s growing balance sheet, which rose above $3 trillion for the first time in January after Chairman Ben S. Bernanke committed to open-ended purchases of Treasuries and mortgage-backed securities to combat unemployment. The Bank of Japan is also expanding its stimulus to fight deflation.
“A significant shift is underway in global central banking,” said Paul Mortimer-Lee, global head of market economics at BNP Paribas SA in London. “There is a worldwide currency war and the ECB seems to be a central bank that is not targeting the real economy as much as the Fed, the Bank of Japan and the Bank of England,” he said. The ECB “risks being the loser.”
The Bank of England will today maintain its bond-purchase program at 375 billion pounds ($587 billion) and hold its key rate at a record low of 0.5 percent, two surveys of economists show. That decision is due at noon in London.
The euro’s gains are causing concern among politicians at a time when at least five of its 17 member states are in recession. French President Francois Hollande this week called for government leaders to steer the exchange rate -- a proposal that was swiftly rejected by German Chancellor Angela Merkel.
Finance ministers and central bankers from the Group of 20 nations may discuss currencies when they meet in Moscow on Feb. 15 and 16.
Draghi’s predecessor, Jean-Claude Trichet, was willing to intervene verbally to influence the euro. In November 2004 and November 2007 he spoke out against “brutal” shifts in currencies to keep it in check.
So far, Draghi has been circumspect. “I never comment on exchange rates,” he said on Jan. 10, while acknowledging that currencies are “certainly a very important element as far as growth and price stability are concerned.”
The ECB estimates the euro-area economy will shrink 0.3 percent this year before posting growth of 1.2 percent in 2014. The euro’s strength may force it to revise down those projections in March, “reopening the door for another rate cut,” said Carsten Brzeski, an economist at ING Group in Brussels. Twelve of 42 economists in another Bloomberg survey forecast an ECB rate reduction in the second quarter.
“The ECB is in a difficult position,” Brzeski said. “A rate cut now would probably do little to reverse the current trend of the exchange rate. Draghi will have to use verbal intervention to limit any further appreciation of the euro without committing the ECB to possible future policy action.”