- Lagarde lays ground for further intervention
- "further monetary stimulus is likely" - ABN AMRO
- Euro's 'best performer' status to be questioned going forward
Above: Christine Lagarde at Monday's ECON Monetary Dialogue. Image by Dominique HOMMEL. © European Union 2019 - Source: EP
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The Euro is one of 2020's top performers, but the period of outperformance that took the single currency to the top of the leaderboard might have come to an end with the European Central Bank lining up its big players to warn they are not comfortable with the pace and extent of the currency's rebound.
A series of verbal interventions on the currency's appreciation have combined with concerns that the Eurozone economy's recovery is faltering to create an impression that the ECB will step up its support at some point in coming weeks, which could stem the Euro's upside potential.
European Central Bank (ECB) President Christine Lagarde told a hearing of the Committee on Economic and Monetary Affairs of the European Parliament that the Euro was a concern and that "it is clear that external value of euro has impact on inflation".
Lagarde signalled actions that could hinder the Euro's appreciation while boosting the economy might well be forthcoming.
Providing a moral framework for further intervention, that could see quantitative easing expanded once again, Lagarde said:
"We are still feeling the impact of the coronavirus pandemic across the euro area. Businesses are facing difficulties, people are losing their jobs, and prospects for the future remain uncertain.
"While euro area economic activity rebounded in the third quarter, the recovery remains incomplete, uncertain and uneven. The public health crisis will continue to weigh on economic activity and poses considerable downside risks to the economic outlook."
Lagarde concluded that "in the current environment of elevated uncertainty, the Governing Council will carefully assess all incoming information, including developments in the exchange rate, with regard to its implications for the medium-term inflation outlook. It continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry’."
A simple principle in foreign exchange markets is that when a central bank embarks on a path of fresh monetary easing (cutting rates, boosting quantitative easing) the currency it issues declines in value.
The resurgence of covid-19 cases, a more expensive Euro and a slowing economic recovery appears to have shifted the thinking at the ECB and further support is being priced as increasingly likely by money markets and financial analysts; a shift in stance that could undermine further Euro appreciation.
"Good news regarding the EU recovery fund is priced, further EUR strength will have to come from European data outperformance. But the resurgence of virus cases in core Europe and recent negative data surprises are making this challenging," says a weekly foreign exchange note from foreign exchange strategists at Barclays.
The Euro has appreciated strongly over the summer months driven by a supportive global economic recovery and Eurozone economic outperformance, while EU countries surprised markets by rapidly arriving at a generous pan-European fiscal support package to minimise the economic impact of the covid pandemic.
The Euro-to-Dollar exchange rate had rallied to record a multi-month high at 1.20 at the start of September before declining amidst a rebound in the Dollar. Of note, it was on this day that ECB Chief Economist Philip Lane became the first official to warn against the Euro's appreciation.
The Euro's strength has been reflected in a higher trade-weighted Euro exchange rate, aided higher by the Euro-to-Pound exchange rate rising to a best of 0.9291 by mid-September.
However, expectations for further ECB action is a potential negative for the Euro outlook and could contribute to expectations that the 2020 rally has reached its limits.
"She struck a dovish tone, which signalled that further monetary stimulus is likely," says Nick Kounis at ABN AMRO Bank N.V. "We think the PEPP will remain the instrument of choice, and we expect it to be stepped up by another EUR 500bn in December, with the duration of the programme likely to eventually run through the end of next year.
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Daragh Maher, Head of Research, Americas/Head of FX Strategy at HSBC says the Euro's gains at the start of the week may have been held back somewhat by recent ECB rhetoric.
Maher cites the ECB’s Ignazio Visco who told a conference in Italy that "the euro’s recent strengthening is worrying us because it generates further downward pressures on prices at a time when inflation is already low... the monetary policy implications are obvious: if the downward pressures jeopardise our price stability objective, we’ll have to intervene."
His comments echo those of the ECB’s De Cos over the weekend who said recent exchange rate movements mean there is "no room for complacency.
"For markets, the question remains as to how quickly EUR moves might trigger action rather than rhetoric," says Maher.
Comments from Fabio Panetta on September 22 meanwhile pointed to what Maher reads as an activist mindset when he notEd that "the risks of a policy overreaction are much smaller than the risks of policy being too slow or too shy."
The Euro-to-Dollar exchange rate is quoted at 1.1673 at the time of publication while the Euro-to-Pound exchange rate is at 0.9083.
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