Mario Draghi is facing yet another headache this year as a strong currency threatens to derail his quest to keep prices stable, with many analysts suggesting there’s no easy way out for the president of the European Central Bank (ECB).
Investors have been flocking to the single currency as the euro zone economy keeps growing and political risks dissipate. However, that could become a problem for the European Central Bank as a stronger currency can mean that European-produced products become pricier and less attractive outside the region. The euro has risen nearly 3 percent against the U.S. dollar since the start of the year, at a time when the ECB has been assessing how to reduce its monetary stimulus — which aims to increase lending and stoke consumer prices.
At the bank’s last press conference in January, Draghi admitted that recent volatility in the exchange rate was a “source of uncertainty.” The ECB’s primary target has always been inflation and not the exchange rate and Draghi — like many central bankers around the world — has been cautious when speaking of his own currency.
However, analysts believe that Draghi wouldn’t be able to talk down the euro, even if he wanted to.
“I believe it will be difficult for the ECB to talk the euro down in a very significant manner as it has already pretty much exhausted its preferred expansionary monetary policy instruments which it could use to weaken the currency (rate hikes and quantitative easing),” said Thu Lan Nguyen, forex analyst at Commerzbank.
“And as the G-20 nations have agreed that they will refrain from manipulating their exchange rates, interventions are not a viable option either. Or even directly talking the euro down for that matter, because other nations would see this as a violation of the agreement as well,” she said.
According to Nguyen, the only option left for Draghi would be saying that a strong appreciation would threaten the ECB’s inflation outlook.
Meanwhile, analysts at Dutch bank ING also said in a note Friday that the ECB won’t be able “to credibly talk down the euro” and expect the single currency to hit $1.30 this year. It was trading about 1.2333 against the greenback on Tuesday afternoon.
“There are three key hurdles why the ECB won’t be able to credibly lean against the euro,” the note said. It mentioned that the euro is not strong yet and thus has further room to grow; higher oil prices are going to mitigate any disinflationary pressures from a stronger euro; and the euro zone economy is doing well and the region can therefore cope with a stronger currency.
Amid these circumstances, Draghi cannot credibility threaten a looser policy stance as it would be “hard to justify in the absence of deteriorating inflation and growth outlooks,” ING said in the note.
According to the latest economic projections by the ECB, gross domestic product should hit 2.3 percent for the euro zone in 2018 and inflation, excluding energy, will reach 1.3 percent. The latter is seen at 1.6 percent in 2019. In January, flash data suggested that inflation grew at 1.3 percent.
“I think that the EUR will hold up well versus a broad selection of currencies on the back of strong fundamentals going forward. However, I think that we are at an interesting juncture for EUR/USD,” said Jane Foley, head of forex strategy at Rabobank.
“There is a large amount of USD-denominated debt outside of the U.S. In view of the concerns about extra supply and (Federal Reserve) tightening, it is reasonable to expect some concerns about liquidity to increase if market confidence deteriorates. This could lend support for the USD,” Foley warned, which could end up giving some relief to the euro.