Euro zone leaders are growing increasingly anxious over the unpleasant side effect of the European Central Bank’s successful effort to defuse the crisis: a soaring currency.
The euro has been climbing just as the 17-nation currency union is back in recession and, at best, faces a feeble recovery. The troubled region could do with a weaker currency that would stimulate exports and counter the softening currencies in Japan, the United States and elsewhere.
The issue is certain to pressure ECB president Mario Draghi, whose pledge to backstop the sovereign debt markets helped ease the crisis, when the central bank meets Thursday.
“Even if it won’t be harmful for everyone, a strong euro is currently as useful for the economic recovery as a screen door in a submarine,” said ING Financial Markets economist Carsten Brzeski.
The euro hit $1.37 (U.S.) last week and was trading Wednesday at $1.36. Against an index of 10 top currencies, it has gained about 7 per cent in the past half year. But it has soared against some, up about 30 per cent against the yen, for example. Since its recent trough in the summer of 2012, the currency has gained more than 10 per cent against the dollar.
The euro’s strength has rattled some of the euro zone’s political leaders, who are putting unsubtle pressure on Mr. Draghi to find ways to bring it back down to earth, even though its value is still well short of its pre-financial crisis peak of $1.60. Some economists predict the euro is now on its way to $1.40 or $1.45.
On Tuesday, French President François Hollande in effect called for a managed exchange rate, although he stopped short of asking the ECB to set short-term targets for the €.
“We can’t let the euro fluctuate according to the mood of the market,” he told reporters at the European Parliament in Strasbourg. “We have to act at the international level to assert our interests.”
Other European leaders share Mr. Hollande’s anxiety, knowing full well that a strong euro could choke off an export-led recovery, put more workers on the dole and jeopardize their chances of getting re-elected. In mid-January, Luxembourg President Jean-Claude Juncker said the euro was “dangerously high.” Belgium’s Fnance Minister, Steven Vanackere, last week said “the risk is real” of an exchange rate war with Japan.
The rising euro affects different countries in different ways.
In theory, Germany, Europe’s top exporter, should worry the most. But historically, German exports have not dipped as the currency climbed. For that, it can thank strong global demand for its high-value-added and specialized products, such as machine tools and tunnel-boring equipment, which are coveted by high-growth countries such as China.
Some of the smaller countries, such as Greece and Portugal, should not be hurt much by the stronger €. Their export market is small and what is exported usually goes to other euro zone countries. The countries that will get hurt most are France and Italy, which rely heavily on exports outside the euro zone but lack the “Made in Germany” cachet that can keep profit margins fat even as the currency climbs.
Mr. Brzeski, of ING, said an increase in the euro’s nominal effective exchange rate by 10 per cent can trim gross domestic product growth by 0.3 to 0.5 of a percentage point. That does not sound like much, but with the euro zone registering no growth, a fall that small would be enough to keep the region in shallow recession and unemployment rising.
Germany was critical of Mr. Hollande’s suggestion that exchange rates be managed. Germany wants the ECB to remain independent and obsessed with fighting inflation. Its message to France and the rest of the euro zone is to counter the rising euro by strengthening competitiveness.
Still, Mr. Draghi will come under pressure Thursday, when the ECB holds its regular rate-setting meeting, to give his views on the €. He is highly is unlikely to use foreign exchange interventions; the ECB has waded into the currency markets only once, in 2000, when the euro was getting too weak for its liking.
With inflation falling and faced with a feeble economic recovery, he could cut interest rates. But they are already so low that one more cut may have no effect on taming the €. The betting is that he will leave rates unchanged.
He could instead “talk down” the euro by predicting that its strength could hurt the recovery. Indeed, if the ECB lowers its euro zone growth forecasts, currency traders may take fright and dump the €. But with the threat of the euro zone’s breakup vastly diminished, the currency is highly unlikely to go under $1.30 any time soon even if Mr. Hollande wants it at that level.