Pros and cons of a strong euro: what will Dragi choose?

Investors are now interested in this: will the central bank be able to weaken the euro with verbal intervention.
The euro has already reached the maximum levels over the past two and a half years, with some analysts confident that this is far from the limit. A strong currency has not only advantages, but also drawbacks, and this fact can greatly complicate the task of the European Central Bank, which this week will take the next decision on monetary policy. Perhaps the head of regulator Mario Draghi will decide on verbal intervention.

Why did the euro rise?
There are several interrelated factors, including a possible reduction in the program of buying bonds from the current volume of 60 billion euros a month and the strengthening of the European economy. Political risks in Europe are dying out, which, in combination with an impressive current account surplus, attracts investment flows to the regional stock and bond markets. Meanwhile, the attitude to the dollar was spoiled by vague forecasts for the US economy and political chaos in Washington, where Trump and his administration unsuccessfully try to pass through Congress a package of incentive measures.

What are the advantages?
A strong economy and a decrease in political risks have changed the attitude towards the euro this year, although in January everything was so bad that many were waiting for him at par with the dollar / Paul Lambert from Insight Investment notes: “if at the beginning of the year you told the members The ECB Board of Governors that the euro will rise because political risks have fallen, unemployment has fallen, the economy has begun to recover, and the market has believed in the impending curtailment of the incentive program, then most likely they would say it’s great. ” Didier St. George of Carmignac also believes that a strong euro is a plus for Europe in many ways. “Since the beginning of the financial crisis, many asset managers preferred the dollar, but now America’s leadership is not so obvious, and the victory of Macron in France and the strengthening of the Franco-German axis helps such alternative currencies as the euro survive the renaissance,” he explains.

What are the disadvantages of a strong euro?
Inflation. More precisely, its absence. Expensive currency restrains price pressure, as imported goods become cheaper. The ECB is worried that it will not be able to achieve the inflation target at 2%, although in August the annual rate rose to 1.5%, but the core inflation stuck at 1.2%. Perhaps, the Bank will have to revise its outlook for inflation downward. GDP is growing at 2.1% per year. But in Bank of America Merrill Lynch believe that a strong euro has not yet reflected on inflationary indicators in full. “It’s too early to draw conclusions,” BofAML is confident. Bank experts believe that the ECB will not simply reconsider the forecasts for a downgrade, but also blame the strong euro, indicating “the potential for further decline.”

More flaws?
The export sector will feel the charms of a strong euro, especially in the most vulnerable countries of the region. The fact is that in 2015 and 2016, the QE-devaluation of the euro contributed to a strong export growth – now, according to Tim Graf of State Street Global Advisers, everything has returned to its previous levels five years ago. Companies are not too happy with the growth of the euro. Since mid-May, European stocks have fallen behind the US by 6% in local currency. During this period, the euro against the dollar increased by 8%. Export-oriented companies feel the most adverse consequences. Morgan Stanley notes that a strong euro is benefiting banks, the utilities sector and retailers, but it harms semiconductor manufacturers and mining companies. However, the fate of exporters is unlikely to be of great concern to the ECB. “The dynamics of the stock market is also not a primary concern,” adds Lambert. “The euro area economy is financed by banks.”

What does all this mean in the context of the upcoming meeting?
In general, a strong euro will not knock the ECB off course, but may be an excuse for delaying and delaying the exit from QE. Analysts at ING believe that the ECB will announce a very cautious curtailment of incentives, beginning in January, and in Rabobank believe that cautious comments will help the regulator to weaken the currency in September and get a breather. Whatever the case, the effect of verbal intervention is not great. Draghi will not be able to achieve a large-scale fall of the euro, because his strength is based on fundamental improvements. “If you give up the fruits of your own policy, you should consider why you need it at all.” In any case, why resort to verbal interventions, if their success is not something that is not guaranteed, but generally tends to zero?

Please follow and like us:

Leave a Reply

Your email address will not be published. Required fields are marked *

Enjoy this blog? Please spread the word :)