Plunging Euro May Help Draghi More Than Week-Old QE ProgramDavid Goodman and Andre Tartar
He may be reluctant to admit it, but the biggest benefits from Mario Draghi’s bond purchases are likely to come from the plunge in the euro.
The European Central Bank’s quantitative-easing program will boost euro-region inflation by 0.3 percentage point this year, with a weaker exchange rate doing most of the work, according to economists surveyed by Bloomberg. The euro tumbled to a 12-year low as the Frankfurt-based central bank unveiled details of its first week of purchases, which are designed to increase the money supply.
“That’s the transmission mechanism that might be the most powerful,” Hans Joerg-Naumer, head of capital-markets analysis at Allianz Global Investors GmbH, which oversees $412 billion, said by phone from Frankfurt on March 11. “They want to keep the euro exchange-rate low.”
ECB President Draghi is counting on his 1.1 trillion-euro ($1.1 trillion) QE plan to rescue an economy that’s barely out of a recession and where consumer prices have been falling for three months. While he acknowledges the economic benefits a weaker euro can bring, Draghi has consistently denied targeting the exchange rate, which smacks of unfair advantage among the global policy community.
In addition to stoking inflation, a weaker currency makes exports more competitive. While the other main effect of QE -- tumbling bond yields from Germany to Spain -- may help governments’ borrowing costs, it’s less likely to have a direct impact on growth.
“The euro weakening is probably the strongest case for a better economy in Europe,” said Poul Kobberup, chief investment officer at PFA Pension A/S in Copenhagen, which oversees about $60 billion. “It’s been weakening quite dramatically.”
The euro slid as low as $1.0458 on Monday, the weakest since January 2003, and has plunged 13 percent this year, putting it on track for its biggest ever quarterly decline. The euro zone’s reliance on exports -- overseas shipments account for almost half of the 19-nation region’s gross domestic product -- makes that slide particularly helpful.
Europe’s shared currency has been falling for months as Draghi prepared markets for his bond purchases and the dollar rallied on the Federal Reserve’s plans to raise interest rates as soon as this year. The ECB announced Monday it settled purchases of 9.75 billion euros of public-sector debt last week.
Goldman Sachs Group Inc. cut its forecast March 13 on the euro, predicting it will fall about 3 percent to $1.02 in three months and reach parity in six months. The median of 34 responses to Bloomberg’s economist survey also calls for euro-dollar parity, with many respondents saying the decline will benefit the economy.
“As the recovery gains steam, there should be a notable upward tick in headline and core inflation, supported by the depreciation of the euro,” Christopher Matthies, an economist at Sparkasse Suedholstein in Neumuenster, Germany, wrote in his response to Bloomberg’s QE survey, conducted March 6-12. The currency decline “is mainly caused by the upcoming tightening of the Fed and the QE program of the ECB,” he wrote.
The average rate on euro-area sovereign debt has also shrunk, declining to 0.424 percent on March 11, the lowest since at least 1995, Bank of America Merrill Lynch indexes show.
The main economic benefits, though, look like coming from the exchange rate. A 10 percent slide in the euro against its major peers adds 0.3 percentage point to GDP, according to an estimate by ING DiBa AG, and the shared currency’s already down 9.3 percent in the past three months versus a basket of its Group of 10 counterparts.
Even so, Draghi has a ways to go before he translates these losses into tangible economic benefits. Euro-zone GDP grew just 0.9 percent last year, while consumer prices dropped 0.3 percent in February from the same month in 2014.
Not everyone thinks he’ll be successful, either. Peter Dixon, an economist at Commerzbank AG, said the cheaper euro may struggle to boost growth given the weakest peripheral economies aren’t big exporters and global demand remains poor.
“It’s not much point having a weaker currency if demand isn’t that dynamic,” Dixon said by phone from London. “Demand matters.”
Questions are being asked as to whether the euro is falling too fast. QE risks “overshooting,” and the “exchange-rate decline is larger than we had expected,” Bank of Italy Governor Ignazio Visco said over the weekend. He also said the bond-buying program reduces economic uncertainty.
The ECB is becoming more optimistic about the economy and boosted its outlook for 2015 growth to 1.5 percent this month, from a previous estimate of 1 percent.
Options trading should give policy makers confidence that further euro losses are in store, too.
The premium for three-month options to sell the euro over contracts allowing for purchases widened to a 2 1/2-year high of 2.6 percentage points in February and was at 2.04 percentage points as of 11:45 a.m. New York time, data compiled by Bloomberg show. That shows traders are betting additional declines are more likely than a rally.
QE programs “definitely drive the currency down,” said Ben Pace, the New York-based chief investment officer at HPM Partners LLC, which oversees $5.5 billion. “Market participants think it’s going to help exports and eventually help the economy.”
(An earlier version of this story was corrected to fix the spelling of Copenhagen.)