Draghi takes aim at euro, seen too strong for comfort
By Lukanyo Mnyanda
European Central Bank President Mario Draghi is taking aim at the euro.
In his strongest words yet on the currency’s advance to its highest level since 2011, Draghi said on Thursday in Vienna that the exchange rate is “increasingly relevant in our assessment of price stability.” He suggested his eight-month-old policy of hinting at future interest rates may address the appreciation that may be holding back growth.
Gains in the euro are both a vindication of Draghi’s success in stabilizing the 18-nation currency bloc after its sovereign-debt crisis and a dilemma. Gross domestic product is growing more slowly than other major economies, and companies such as sportswear maker Adidas AG say the currency’s rise is hurting exports.
“The only thing Draghi did not say was that the euro is ‘brutally high,’” Steven Englander, the New York-based global head of Group of 10 currency strategy at Citigroup Inc, wrote in an e-mailed note to clients after Draghi’s comments. “There have been an ascending series of comments from ECB officials soft-circling the (euro) as a concern.”
Traders took notice, pushing the euro to as low as $1.3846 from as high as $1.3967 on Thursday, an intraday drop of 0.9 percent. The shared currency was little changed at $1.3865 as of 9:08 a.m. in London.
Even with the declines, the currency is enjoying its best start to a year versus the dollar since 2011, gaining 0.8 percent. Options data show the shared currency has a 49 percent chance of reaching $1.45 this year, compared with 34 percent odds of slipping to the $1.30 median forecast in a survey of strategists by Bloomberg.
“The ECB is reacting in part to the trend in the euro,” Sebastien Galy, a senior currency strategist at Societe Generale SA in New York, said on Thursday. While “$1.40 means little to an economist, it does to a lot of corporates complaining to their central banks.”
Morgan Stanley and UBS AG say the euro’s gains aren’t compatible with the ECB’s goal of repairing an economy that shrank 0.5 percent last year and boosting inflation. Consumer prices rose 0.8 percent in February from a year earlier, half the ECB’s 2 percent target, while core inflation, which is stripped of volatile components such as energy and food, was 1 percent.
More than six years ago, Draghi’s predecessor as ECB president, Jean-Claude Trichet, described the euro’s advance as brutal in November 2007, a day after it climbed to a record $1.4731.
“The ECB will eventually have to take action and that will put the euro back under pressure,” Ian Stannard, the head of European currency strategy at Morgan Stanley in London, said in a March 11 phone interview. “But certainly in the near term, the euro is going to be well supported.”
Morgan Stanley sees the euro climbing to as high as $1.42 before dropping to $1.24 by year-end.
The currency has steadily risen from 2012’s low of $1.2043 as Europe recovered from a crisis that saw Greece, Portugal and Ireland take bailouts. In July of 2012, Draghi said the ECB was “ready to do whatever it takes” to preserve the euro.
Traders pushed the euro higher even as the region suffered through a recession. It jumped 0.9 percent against the dollar on March 6, the most in six weeks, when the Frankfurt-based ECB refrained from cutting rates or introducing new stimulus.
While policy makers predicted that growth in the euro-area economy would quicken to 1.8 percent by 2016, they also said inflation would stay below-target in the next two years and that the jobless rate would remain above 11 percent.
Interest-rate guidance “creates a de facto loosening of policy stance, as real interest rates are set to fall over the projection horizon,” Draghi said in Vienna. “At the same time, the real interest-rate spread between the euro area and the rest of the world will probably fall, thus putting downward pressure on the exchange rate, everything else being equal.”
Draghi’s comments were the latest example of ECB officials becoming more vocal about the currency’s strength. He said March 6 that the exchange rate had cut about 0.4 percentage point off inflation, while Governing Council member Christian Noyer was more forthright four days later, saying a stronger euro creates unwarranted pressure on the economy.
Economists are split on whether the ECB would act to prevent the euro from strengthening, according to the Bloomberg Monthly Survey published on Thursday. Twenty-one of 40 respondents said the ECB would take action, while 20 said they wouldn’t, according to the survey carried out March 7-12.
Companies are feeling the effects. Herzogenaurach, Germany-based Adidas, which gets almost 75 percent of revenue outside western Europe, said this month that 2014 profit would be as much as 17 percent lower than analysts’ estimates because the euro’s strength is weighing on sales. Printing-press maker Heidelberger Druckmaschinen AG cited the currency on Feb. 5 as one of the reasons for an anticipated drop in earnings.
Even with a focus on the exchange rate, the ECB’s failure to implement more measures to boost competitiveness and stoke consumer prices may leave the euro open to further gains. It also increases pressure on policy makers to cut the bank’s main refinancing rate from a record 0.25 percent and to implement a negative deposit rate for the first time when they meet April 3.
“A lot of people are talking about the $1.40 level on the euro,” Marc Chandler, a currency strategist in New York at Brown Brothers Harriman & Co, said in a phone interview on Thursday. “Above $1.40, I think people will also come around to my view that it increases the likelihood the ECB is going to cut next month.”
While the euro-area economy emerged from its longest recession on record in the three months through June, it hasn’t grown faster than 0.3 percent in any quarter since. The ECB forecasts growth will accelerate to 1.2 percent this year, compared with an average of 2.1 percent in the Group of 10 developed nations, according to a Bloomberg economist survey.
Should policy makers “start to believe the euro is going to be too high with material consequences for economic performance and asset performance, then they will respond,” Geoffrey Yu, a senior strategist at UBS AG in London, said in a March 11 interview. “Markets will test the ECB at some point, and then let’s see what kind of policy response they come back with.” The euro may drop to $1.33 in three months, he said.
The currency has also been supported as investors sought a haven during the crisis in Ukraine and by the relatively high yields offered by its bonds, particularly those of peripheral nations such as Spain. Spain’s benchmark 10-year bond yielded 3.38 percent on Thursday -- down from as much as 5.59 percent last year, though higher than Germany’s 1.54 percent and the 2.65 percent rate on the equivalent US Treasury.
“If you look at peripheral yields, they’re still at a relatively high level,” Neil Mellor, a London-based currency strategist at Bank of New York Mellon, said in a phone interview on Thursday, adding that the euro will drop toward $1.30 this year. “There is clearly rationale for further ECB measures on the basis of euro strength, but it comes down to politics.” [Bloomberg]