Europe's Quiet Currency War Besets Nations Losing Inflation Grip

  • Denmark to Czech Republic facing money inflows from ECB policy
  • Riksbank highlights exchange-rate risk to inflation targets

You don’t have to use the euro for Mario Draghi to be the central banker setting your monetary policy.

QuickTake Currency Wars

From Stockholm, where the Riksbank published the minutes of its latest policy meeting on Tuesday, to Prague, Copenhagen and Zurich, officials in countries circling the currency bloc are waiting for the European Central Bank president to say next month whether he’ll expand stimulus. Only then will it be clear whether they’ll need to retaliate with more asset purchases, rate cuts and currency interventions of their own to dig in against imported disinflation.

Draghi’s bonanza of cheap cash is depressing financial returns in the euro area and driving investment flows into neighboring countries, pushing up their currencies and defeating their efforts to hit their own inflation targets. Looser monetary policy is in the cards even in countries where economic growth is strong and asset markets are overheating.

“These countries don’t want to be the losers in the currency war they think the ECB is participating in,” says Marchel Alexandrovich, senior European economist at Jefferies International Ltd. in London. “It’s a zero-sum game. If you’re trying to devalue, then there’s always someone on the other side of that trade.”

After Draghi announced a 1.1 trillion-euro ($1.2 trillion) bond-buying program on Jan. 22, holdings by euro-area residents of debt and equity in the nine European Union countries outside the currency bloc soared to fresh records, ECB data show. Total portfolio investments rose more than 9 percent in the first quarter to 2.05 trillion euros.

The movement of cash had the effect, not unwelcome at the Frankfurt-based ECB, of helping push the euro down against currencies including the Swedish krona, Poland’s zloty, the Czech koruna and the Hungarian forint. Most dramatically, the Swiss National Bank on Jan. 15 preempted the ECB’s decision by abandoning its cap on the franc.

While ECB officials have repeatedly said they don’t target the exchange rate, they’ve acknowledged that a weaker euro helps revive the economy and inflation by boosting exports and pushing up import prices. The single currency has dropped almost 7 percent on a trade-weighted basis this year and since the ECB started considering new stimulus has dropped to the weakest in three months.

Price Stagnation

The flipside is that countries seeing their currency strengthen face downward pressure on inflation rates already suppressed by falling energy costs. Swedish inflation is at 0.1 percent compared with a target of 2 percent. Denmark and the Czech Republic are at 0.2 percent. Consumer prices are declining in Switzerland, Poland and Hungary.

“An earlier and faster krona appreciation than forecast by the Riksbank would risk contributing toward weaker inflationary pressures,” Riksbank Governor Stefan Ingves said in the Swedish central bank’s minutes. “Similar questions have been raised in a few other smaller European countries with their own currencies: Denmark, Switzerland and the Czech Republic. For these three countries and Sweden, this is very much a matter of trying to avoid domestic effects of the ECB’s monetary policy.”

With euro-area prices also stagnating and the ECB considering whether more stimulus is needed, countries that have eased policy this year face having to do so again, even if unwarranted by domestic conditions.

Swiss real-estate prices remain risky, according to a measure by UBS Group AG, yet SNB President Thomas Jordan has said the deposit rate could fall further from the current minus 0.75 percent. The central bank will hold its quarterly policy review on Dec. 10, exactly one week after the ECB’s next meeting.

Swedish property prices have risen almost 50 percent since 2009 and gross domestic product is growing twice as fast as the euro area, yet looser policy may be coming. Deputy Governor Per Jansson said last week that the Riksbank is moving closer to intervening in the currency market, with little scope to cut interest rates further or buy more government bonds.

Housing Boom

“The more the ECB does in terms of quantitative easing, the more the Riksbank needs to do in order to avoid the Swedish krona becoming too strong,” said Par Magnusson, an economist at Swedbank AB in Stockholm.

In Denmark, unemployment is below 4 percent and the price of owner-occupied apartments rose 10 percent in the past year -- yet action may be needed if the krone’s peg to the euro is to be maintained.

Moreover, figures published Tuesday showed inflation slowed in October, and Arne Lohmann Rasmussen, head of fixed-income research at Danske Bank A/S in Copenhagen, says conventional policy may have run out room.

“The deposit rate is probably already at the effective lower bound at minus 0.75 percent,” he said. “If the Danish central bank has to respond to any new ECB actions that might trigger a stronger Danish krone, they’ll probably have to step-up intervention again.”

Limited Mandate

Czech central bankers are having to push back the date on which they can give up their unpopular currency cap. The Czech National Bank is struggling to normalize monetary policy even though it forecasts 2015 GDP will expand by 4.7 percent. The benchmark interest rate has been at 0.05 percent since 2012.

ECB officials can do little more than shrug when confronted with the distortions they’re helping to cause.

“We are mindful of the impact of our decisions on the rest of the world, and in particular on neighboring economies,” Executive Board member Benoit Coeure said on Nov. 4. “But our mandate is limited to the euro area.”

The ECB isn’t immune to policy overspill. Its December decision may be influenced by the likelihood of the U.S. Federal Reserve raising its own borrowing costs after seven years of near-zero rates. In that event, the best-case outcome for Draghi’s neighbors would be a diversion of global financial flows toward the U.S., and a stay of action in Frankfurt.

Inserted into the debate of whether more stimulus for the euro area is needed, comes persistent criticism of the quantitative-easing program, particularly from Germany. On Tuesday German ex-lawmaker Peter Gauweiler said he filed one of three new complaints challenging the ECB at the country’s top court.

Desperate Times

In the meantime, one nation has avoided contorting its policy framework to respond to euro-area pressure. Its approach: Ignore the inflation target.

Rather than expand its balance sheet in a vain attempt to stoke prices, the National Bank of Poland has reinterpreted its inflation goal, and tolerated the longest bout of deflation since the communist era. Marek Belka, the NBP’s governor and a former International Monetary Fund official, has deferred a decision on cutting rates until next year, citing a healthy economy showing no signs of suffering.

That’s a sign that with the ECB dominating monetary conditions for Europe, central banks in faster-growing economies may need to consider whether a narrow focus on consumer-price gains is the best measure of their success.

“Competitive devaluations used to be about getting more growth, and now we’re trying to get more inflation without that having anything to do with the underlying economy,” said Anatoli Annenkov, an economist at Societe Generale SA in London. “That shows the desperation we’re in.”

(An earlier version of this story was corrected to show the krone is pegged to the euro)

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