Euro strength here to stay, unless ECB steps in

Wed Apr 16, 2014 10:59am EDT
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By Anirban Nag and Eva Taylor

LONDON/FRANKFURT (Reuters) - Many of the factors driving the euro exchange rate to levels that have set off alarm bells at the European Central Bank are unlikely to go away on their own, part of the reason the bank has been threatening action.

The euro is still off the peaks of 2011, but because inflation is now heading close to zero, the ECB is sensitive to its current rate because anything that makes it stronger pushes deflation nearer.

Mario Draghi, the ECB president, said at the weekend a strengthening exchange rate would trigger more policy action.

That could be some form of quantitative easing, or asset buying, to get more money into the system and hence make the euro cheaper.

Indeed, one reason for the euro's relative strength is that central banks in the United States and Japan have been printing dollars and yen for such bond-buying programs, while the ECB's euro balance sheet has been shrinking.

"If the ECB really wants to get the euro down, then it can take a lesson from the Bank of Japan," said Nick Kounis, head of economic research at ABN AMRO. "Large scale monetary easing or quantitative easing tends to be bad news for your currency and tends to pull it down significantly."

The euro has gained 2.3 percent against the dollar and nearly 6 percent against the yen in the past six months. On a trade-weighted basis - against a basket of currencies - it stands just below recent 2-1/2 year highs, having risen 5 percent in 2013.

It is trading at around $1.38, slightly above the $1.36 rate on which ECB staff based their inflation forecasts through to 2016. The next staff forecasts are on June 5 and a downward adjustment could add ammunition for policy action.   Continued...

The euro sign landmark is seen at the headquarters (R) of the European Central Bank (ECB) in Frankfurt September 2, 2013. REUTERS/Kai Pfaffenbach