There is every reason for investors to expect a further slide in the euro’s value versus the dollar as policymakers in Europe make calculated reactions to the recent terrorist attacks in Paris. In fact, a yet weaker euro might prove a tonic for a currency bloc seeking to maximise its export potential and ignite some price inflation.
The European Central Bank (ECB) was already edging towards a further easing of euro zone monetary policy even before the November 13 atrocities in the ‘City of Light’, which heightened the sense of political uncertainty in the currency bloc, reinforcing the ECB’s arguments for such action.
“The Governing Council will discuss whether there is a case for further action in the context of heightened uncertainty. This is a key issue,” said ECB Executive Board member Peter Praet on November 16, adding that “a possible de-anchoring of inflation expectations together with a lot of slack is a dangerous cocktail.”
A cynic might argue that looser monetary policy cannot hope to address issues of political uncertainty but a central bank can only pull the policy levers at its disposal, and being seen to be doing something to try and support an economic recovery, that Praet characterised as “fragile,” will be seen as preferable to doing nothing.
Whether or not a further expansion of the ECB’s current programme of quantitative easing will make a tangible difference to the economic situation is open to question, but the likelihood must be such a move will prove a constituent part of any suite of new policies ECB President Mario Draghi will unveil on December 3.
In early November, HSBC analysts argued that, globally, unconventional monetary policy (UMP) had “reached the point of diminishing returns” and that markets were “at the point of quantitative exhaustion” but the ECB will surely conclude that additional UMP measures are a part of their toolkit to be deployed.
Another tool may well be to cut their deposit rate, currently set at minus 0.2 per cent, even further into negative territory.
Again, there are arguments that such action may not have the desired effect although as, in Praet’s words “our own experience with a negative deposit rate was more favourable than we initially thought.”
Others might argue that continued yield suppression encourages savers to put more money away, attempting to make up the interest shortfall through an expansion of their saved capital, rather than to start spending as the monetary authorities might hope.
There is also an argument that very low interest rates are a disincentive for lending institutions to make new loans as the returns are insufficiently attractive but, though it is unproductive for the wider economy, act as an incentive, to keep rolling over bad loans rather than take the write-offs.
Why would lenders take the hits if opportunities to make back the losses in fresh loans are seen as limited?
In truth however, whichever side of the argument is preferred, the implications for the euro are for continued weakness.
Those who believe in the success of a further loosening of euro zone monetary policy relative to other major economies, must also rationally compute that those same UMP measures will weigh on the value of the euro anew.
Those who believe such measures will have no material impact on the euro zone’s “fragile” economic recovery can have absolutely no reason to expect the euro to rise in value and every expectation that, given that the ECB is on record as saying it will do “whatever it takes” to achieve its goals, the euro will continue to weaken.
There is also the inescapable fact that the euro/dollar exchange rate is a two-sided equation, and at the same time as the ECB is logically deploying the monetary policy tools at their disposal to ameliorate a difficult domestic economic and political situation, the US Federal Reserve is seemingly on the cusp of raising interest rates on December 16.
“The October 2015 FOMC statement indicated that it may be appropriate to raise the target range for the federal funds rate at the next meeting in December,” said Fed Vice Chairman Stanley Fischer, albeit speaking on November 12 one day before the terror attacks on French soil.
December 2015 should see the ECB ease policy while the Fed tightens. There is no reason, therefore, why the euro should stop falling against the dollar just yet.