ECB Studying If Differences With Fed Policy Boosting Euro


European Central Bank policy makers have agreed to look deeper into the euro’s appreciation against the dollar since the start of the pandemic, focusing on whether it’s driven by differences in stimulus policies compared with the U.S., according to officials familiar with the matter.

The review could shape how the ECB responds to an issue that has alarmed policy makers, who worry that the euro’s strength over the past year depresses inflation that is already below zero. That could force the central bank to provide more monetary stimulus, even as it acknowledges mounting risks to financial stability.

The ECB’s Governing Council noted during last week’s meeting how an increase in U.S. market interest rates in recent months failed to propel dollar gains, the officials said. Instead, the greenback has weakened.

The officials asked not to be identified because the discussions were private. An ECB spokesman declined to comment.

The euro erased most of its daily gains immediately after the news. It was up 0.1% at $1.2154 at 6:44 p.m. Frankfurt time.

ECB Studying If Differences With Fed Policy Boosting Euro

The euro gained almost 9% against the dollar last year, the biggest annual jump since 2017, and rose by almost 5% in the final two months. It’s near a record high on a trade-weighted basis against major currencies, putting downward pressure on import prices.

The yield on 10-year Treasuries has almost doubled since July to 1%. The German equivalent -- the closest the euro zone has to a benchmark government bond -- has held at around -0.5% over the same period, signaling that investors believe the U.S. economy will outperform.

That outlook was backed by updated International Monetary Fund forecasts on Tuesday predicting U.S. output will expand 5.1% this year, more than recouping last year’s contraction. The IMF cut its growth forecast for the euro zone, struggling to roll out its vaccination program, to 4.2%, which means the bloc won’t return to pre-pandemic levels until 2022.

Some analysts suggest that expectations of additional U.S. fiscal stimulus are weighing on the dollar as they stoke fresh concerns over America’s twin deficits. The greenback has also underperformed currencies like the yuan, as China’s economic recovery dwarfs that of the U.S..

The ECB flagged the exchange rate as a risk in September and included it in its policy statements in October and December -- an unusual move that highlighted the extent of their concern.

While the currency has stabilized this year, and wasn’t referred to in last week’s policy statement, President Christine Lagarde reiterated in her press conference that officials will monitor its impact on inflation.

If it does need to act, it could turn to a tool it hasn’t used during the pandemic -- though conservative members of the Governing Council might balk to avoid an inflationary post-virus recovery, according to Jordan Rochester, a foreign-exchange strategist at Nomura International Plc.

“What could the ECB do about this? Cut or threaten to cut rates -- make it credible and the market will hold off buying the euro,” he said in a report. “But they missed that window during the depths of last year’s panic and the hawks on the council probably will hold sway.”

ECB Studying If Differences With Fed Policy Boosting Euro

The ECB’s emergency stimulus during the pandemic relies largely on a 1.85 trillion-euro ($2.25 trillion) bond-buying program and a series of ultra-cheap long-term loans to banks. Its main interest rate was already one of the lowest in the world at -0.5% before the pandemic.

The Fed cut interest rates by 150 basis points to near zero in March as the coronavirus spread, and officials have signaled they’ll hold them there through at least 2023.

They also launched nine different lending programs to keep the U.S. economy afloat, and have promised to spend at least $120 billion a month on asset purchases until “substantial further progress” is made on employment and inflation.

Separately, but also with implications for the exchange rate, the U.S. government has pumped in more fiscal aid than the euro zone. The U.S. budget deficit widened by an amount equivalent to about 11% of gross domestic product in 2020.

The combined deficits across the 19 euro-zone nations expanded by around 9% of total GDP. European fiscal stimulus is also highly fragmented, varying widely by country and focused on keeping companies and jobs afloat even when businesses are forced to suspend operations.

©2021 Bloomberg L.P.

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