ECB strives to contain Euro – ANZ

ECB officials have been clear that sustained gains in EUR/USD from current levels may prove problematic in achieving the central bank’s medium term inflation goal, explains Brian Martin, Research Analyst at ANZ.

Key Quotes

“The exchange rate is not a policy tool but, if sustained appreciation were to undermine its credibility, the ECB would probably need to recalibrate its monetary policy settings. In other words, the ECB may adjust its policy framework if the euro becomes too strong.”

“However, the ECB is pragmatic about exchange rate movements and acknowledges that much of the recent appreciation can be justified on endogenous grounds (better euro area growth, inflation etc). The EA’s strong balance of payments position (c/a surplus 3% of GDP) and improved fiscal accounts (budget deficit 1.5% of GDP) also act to promote safe-haven qualities during times of elevate geopolitical risk, as has been the case recently. Outright efforts to weaken the exchange rate would be facile in the current climate, and we regard recent ECB reference to the exchange rate as an effort to slow the euro’s rise and rebalance market expectations around exchange rate risks rather than an outright effort to weaken the euro.”

“In addition, the factors that have helped to weaken the dollar from a US perspective seem to be receding.” 

“The dip in US inflation over the spring and early summer seems to be passing as the specific itemised factors that drove inflation down seem to be normalising. In August, headline CPI rose 0.4% m/m and the core index rose 0.2% m/m. That coupled with overwhelming evidence that the underlying expansion in economic activity remains solid has contributed to the FOMC’s decision to leave the dot points for median fed funds projections unchanged. The median estimate anticipates one more 25 bps hike in rates this year and three 25 bps rises in 2018.”

“Meanwhile, Washington is keen to progress the spirit of President Trump’s tax reform agenda and there appears to be common ground between the White House and Congress on aspects of this. Some modest fiscal expansion may therefore be in the offing near term which would work to support growth further. That policy dynamic should help to steady the USD.”