(Bloomberg) --
At what point will the euro’s advance become an unavoidable problem for the European Central Bank, and how will it be able to react given its limited monetary firepower?
Even though euro-area policy makers don’t target the exchange rate, they have repeatedly worried that bouts of euro strength could undermine growth in the export-heavy economy, which is already showing signs of strain in the face of the coronavirus outbreak.
In the aftermath of the Federal Reserve’s interest-rate cut, the euro is trading around an eight-month high, touching $1.1355 on Friday. That took the shared currency up by over 5% from its late-February lows, and on course for its strongest week against the greenback since 2016. Options markets are expecting a further advance, leaving investors on watch for a response from Frankfurt on Thursday.
But with the European Central Bank deposit rate now at -0.50%, meaning institutions must pay to store money there, and its bond-buying program recently restarted, there are doubts about its ability to move the needle on the currency.
“The ECB will be a ‘price taker’ rather than a ‘price maker’ on the global currencies market,” said Koon Chow, a London-based senior strategist at Union Bancaire Privee, in emailed comments. “The Fed has demonstrated once again an ability to move quicker and more aggressively than anyone else. The rise in the euro probably hurts for the ECB. But it’s not something they can do much about this time around.”
Policy makers have periodically inserted language into their statements that warned of currency volatility becoming a source of uncertainty that requires monitoring.
Such a reference last resurfaced in January 2018 after the euro surged to the strongest level against the dollar in more than three years. It also made its appearance in September 2017 after a 14% gain since the start of the year. Back then the euro was around $1.25 and $1.20, respectively.
Euro Options Eye $1.15
It is likely that policy makers will have to pay attention to exchange rates once again, as they struggle to foster economic growth. The euro’s resurgence may meet some technical resistance around $1.14, according to traders. According to Bloomberg currency forecasts the euro will trade at $1.11 in the middle of 2020. Even there, it would be defying a prediction this week from ECB Vice President Luis de Guindos that it should hover around $1.10.
Market positioning data also disagree with de Guindos. Numbers from the Depository Trust & Clearing Corporation show a strong interest over the past month for trades that pay out should the euro rise to $1.15, a level unseen since January 2019.
And there are already calls for deeper economic stimulus.
“The ECB should and will also step up purchases of corporate debt by 10 billion euros ($11 billion) a month as part of the credit-easing push,” said Ernie Tedeschi, an analyst at Evercore ISI, in a note.
“We also believe that the ECB will end up being forced to cut rates 20 basis points by the summer to contain euro appreciation. The first 10 basis points might come by the scheduled March meeting but this is not guaranteed.”
Previous attempts to talk the euro down have largely succeeded without such direct action. The ECB only intervened in 2000 and 2011, both times to strengthen the currency. The latter was part of coordinated move by the Group of Seven richest nations.
That didn’t stop U.S. President Donald Trump back in June from accusing then ECB chief Mario Draghi of trying to weaken the currency with a promise of additional stimulus, allegedly to gain competitive advantage over the U.S.
That’s another reason for Christine Lagarde to tread carefully, even after the ECB’s new president pledged to act if needed. Money markets are pricing a 90% probability that the ECB will lower its deposit rate by 10 basis points at its meeting next week.
But bets on volatility in the euro over coming weeks suggest that investors see the Fed to cut rates again at its meeting on March 18.
“For sure it doesn’t help the ECB,” said Anatoli Annenkov, senior economist at Societe Generale SA in London. “But it was always in the cards that aggressive cuts by the Fed would not be possible to be matched by the ECB.”
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