Mario Draghi’s strategy for reviving the euro area looks like devaluation.
While the European Central Bank president says the exchange rate isn’t a policy target, officials aren’t secretive about their approval of the currency’s 9 percent slide. The depreciation increases the cost of imports and boosts exporters’ competitiveness, aiding the effort to revive inflation that data tomorrow will probably show is at the weakest since 2009.
The euro dropped from a 2 1/2-year high in May as officials unveiled a medley of stimulus measures. It consolidated below $1.30 when Draghi cut rates this month and signaled a willingness to grow the ECB’s balance sheet by as much 1 trillion euros ($1.3 trillion). Details of a plan to buy assets will probably come this week after the Governing Council meets in Naples, Italy.
“When Draghi mentioned expanding the size of the balance sheet, I think he was secretly thinking of the exchange rate,” said Martin Van Vliet, senior euro-area economist at ING Groep NV in Amsterdam. “I’m sure he’s happy to see that the euro has been going down. He’s well aware that one important channel of policy transmission is the exchange rate.”
Since the last meeting, Governing Council members have joined a chorus of officials highlighting the role of the euro, while Draghi said the devaluation reflects a divergence between Federal Reserve and ECB policy. Such remarks evoke language used in competitive devaluations, where nations try to boost exports by driving their currencies down.
The ECB may look past conventional measures to maintain pressure on the euro after saying this month that interest rates have reached the lower bound. The 24-member council will leave the benchmark rate unchanged at 0.05 percent and the deposit rate at minus 0.2 percent on Oct. 2, according to all economists in a Bloomberg News survey.
The currency slumped to $1.2677 last week, the least since November 2012, after reaching $1.3993 on May 8, just before Draghi said officials were “comfortable” with taking action. He then cut interest rates twice, offered cheap long-term loans to banks and announced a plan to buy asset-backed securities and covered bonds.
“The ECB’s policy has been fairly effective in weakening the euro,” said Nick Matthews, senior economist at Nomura International Plc in London. “Clearly the exchange rate is one channel by which the ECB is measuring the effectiveness of its policy measures.”
Draghi told reporters in March that “as a rule of thumb” each 10 percent permanent effective exchange-rate appreciation lowers inflation by around 40 to 50 basis points.
“One of the major impacts we sought with our decisions was on the exchange rate,” Belgium’s Luc Coene said in a Bloomberg News interview after the September decision. Italy’s Ignazio Visco said a weaker euro is “the right response” to the ECB action.
Whether the policy will also be effective in boosting consumer prices remains to be seen. Inflation probably slowed to 0.3 percent this month, the weakest since October 2010 and a fraction of the ECB’s goal of just under 2 percent, according to the median of 36 estimates in a Bloomberg survey. The bank’s preferred measure of medium-term inflation expectations is near a four-year low.
Draghi has said policy makers will take further action to boost prices if needed. With interest-rate cuts off the table, that puts the focus on asset purchases and targeted loans as he seeks to steer the balance sheet back toward levels seen at the start of 2012, when it totaled about 3 trillion euros compared with 2 trillion euros now.
His plan got off to a weak start this month when banks took just 82.6 billion euros in four-year loans, less than all the estimates in a Bloomberg survey of analysts.
The ECB president left open the question of whether to implement large-scale purchases of sovereign debt, or quantitative easing. That measure could prompt resistance from Germany, the region’s largest economy. Bundesbank President Jens Weidmann has spoken out against government-bond buying, and he opposed the rate cuts and asset-purchase programs this month.
While exchange-rate developments are being monitored by officials, the success of the ECB’s policies depends “critically” on governments pushing through structural reforms, Draghi said last week.
For now though, with surveys showing economic confidence sinking and the euro-area recovery faltering, the exchange rate may prove to be the best channel for boosting price expectations quickly.
“Foreign-exchange developments are more relevant for the ECB than before,” said Frederik Ducrozet, an economist at Credit Agricole CIB in Paris. “There is a huge gap between the official position and what they intend to do or target in practice.”