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Draghi Chews on Euro Exchange Rate Strength in European Parliament Testimony

ecb press conference frankfurt july 2017

The strength of the Euro has been highlighted as a potential risk to the Eurozone's economic and inflationary outlook by the President of the ECB.

Further pressure was heaped on an already under-pressure Euro at the start of the week following the appearance of European Central Bank chief Mario Draghi who bit deeper into the subject of exchange rate strength before a European parliament committee.

The ECB president warned again that the eventual shape of the central bank's tapering measures will be contingent in-part on where the exchange rate goes over the coming weeks.

Tapering refers to the ending of the Bank's monetary stimulus programme that includes the printing of money to purchase Eurozone bonds. The Euro has been running higher through 2017 on the assumption that the programme's end will be announced near year-end.

Draghi told the European Parliament Economic and Monetary Affairs Committee that, the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring, saying:

"Downside risks continue to exist, mainly related to global factors and developments in foreign exchange markets."

The Euro has risen sharply over the course of 2017, with a 13% gain on the US Dollar being of potential unease to policy makers as a stronger Euro caps inflation. The ECB has been implementing extraordinary policy measures over recent years to try and push inflation in the Eurozone back to 2.0%.

Euro performance

As such, there is a chance the ECB might delay the ending of these measures to try and put a lid on the Euro and thus help inflation gain some traction.

Fear of such a move has been a long-running feature that has certainly contained exhuberance in the Euro over recent months.

Draghi noted a sustainable move higher of Eurozone inflation requires the absorption of further economic slack in the Euro area and a "very ample degree of monetary accomadation".

Nevertheless, the ECB will probably accept the recent appreciation of the Euro and as such Draghi reiterates that the ECB will decide later this year on a re-calibration of their instruments that maintains the degree of monetary support that the euro area economy "still needs to complete its transition to a new balanced growth trajectory".

Some may have hoped the ECB chief would offer an extension of the kind of hawkish rhetoric deployed in Sintra, in June, which lit a summer-long fire under the common currency.

However, Draghi kept with the script set out at the ECB's most recent meeting, singling out the Euro's recent success as a key risk to the ECB inflation forecasts. 

"Risks surrounding the euro area growth outlook are broadly balanced. At the same time, downside risks continue to exist, mainly related to global factors and developments in foreign exchange markets,” Draghi says.

"We still see some uncertainties with respect to the medium-term inflation outlook. Most notably, the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability."

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Euro Hit by German Election Uncertainty

The main driver of Euro weakness at the head of the new week rests with a bout of political uncertainty pertaining to the Eurozone's largest economy. 

The Euro-to-Dollar rate was quoted 0.63% lower at 1.1871 at the time of writing while the Euro-to-Pound rate was 0.52% lower at 0.8785.

Sunday's German election saw voters migrate away from the traditional pillars of German politics and into the hands of smaller alternative parties who now threaten a shakeup of the status quo in Berlin.

Merkel’s CDU party saw its vote share slip by about 8% which is similar to the increase in vote share enjoyed by the Far Right’s AfP.

The problem for markets is the uncertainty posed by the horse-trading required by Merkel to form a Government.

The SPD, Germany’s second largest party disappointed having secured only 20% of the vote, much less than had been anticipated by the polls.

Although they could have formed a coalition with Merkel’s CDU Party, which would have been a smooth way for Merkel to form a government, they have ruled themselves out of power and said that they will remain in opposition for Merkel’s fourth term as Chancellor.

“This leaves investors’ facing a period of uncertainty as Merkel tries to form a coalition government with the smaller parties,” says Kathleen Brooks at City Index.

“Coalition talks will be difficult, they always are. After losing heavily to the AfD in Bavaria, CSU will be prickly, as will the resurgent FDP and the left wing of the Greens. But Merkel is good at bridging such differences,” says Holger Schmieding, chief economist at Germany’s Berenberg.

 

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