Euro Poker

April 24, 2014

The European Central Bank’s use of verbal intervention to contain the euro’s strength is producing diminishing results.  A change in this tendency is unlikely during the weeks just ahead.

The ECB Governing Council at the April meeting felt that more information needed to be gathered before broadening unconventional monetary stimulus.  Much more pertinent data will be learned by the early June meeting than when the Council meets next in early May.  The Council has 24 members, a pretty unwieldy total, and the tolerance of members for sub-target inflation in the short term varies widely.  A large shortfall of actual inflation — now at 0.5% — from the medium-term target of 1.7-1.9% has been accepted by the majority because measures of expected inflation remain close to the medium-term goal.

Verbal intervention by Draghi and other ECB officials is perceived as a bluff.  Almost two years have passed since the ECB president’s promise to do “whatever it takes” to preserve the euro.  The effectiveness of those three words has far exceeded initial observations in the marketplace, yet the promise has not required much more than timely verbal threats of possible new measures.  For decades, a revealed truth in currency management has been that threatened currency support is generally more effective than actual policy change.

The euro is rather stable and not strengthening rapidly.  Quite the contrary, its value against the dollar was as high as $1.3807 on April 3, three weeks ago, and such is very close to its present quote.  There has likewise been little net variation in the euro’s yen cross.   The euro may be pricier than desired not becoming more so at a pace that is unmanageable.

The Ukraine crisis, a downside risk for the euro, is now old news.  Although not defused, this geopolitical danger zone is losing the element of surprise and therefore unlikely to hit financial markets as hard as it would have done had Russia just seized all of Eastern Ukraine when it annexed Crimea.

U.S. authorities aren’t going to complain about the softer dollar against the euro.  In fact, they welcome such as an offset to the dollar’s strengthening trend against the yen.  U.S. manufacturing has been staging a comeback, and the trade deficit is manageable and below levels that might lift long-term U.S. interest rates.  That said, America’s deficit juxtaposed against Euroland’s wider surplus continues to support the euro at levels closer to $1.40 than $1.30.  The euro area surplus was EUR 244.3 billion in size during the twelve months to February, up from EUR 149.3 billion a year earlier.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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