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Euro drops on ECB fears the currency is now too strong

The euro’s gains against currencies including the dollar and the pound have been enough to alarm European Central Bank policymakers, who fear the currency could overshoot beyond levels justified by growth.

The concerns were raised when rate-setters met on July 20 to discuss policy, and are including in minutes of the event published yesterday.

The level of concern caught the market by surprise and sent the euro to a three-week low against the dollar of below $1.17. The euro weakened to 91.04p against sterling.

“The reality is the ECB is definitely more concerned than the market gave it credit for,” said Simon Derrick, chief market analyst with Bank of New York Mellon in London.
“I think it is entirely possible you could see further downward pressure on the euro from here.”

A recent bounce in the euro, helped by strong growth levels, is making exports less attractive and imports cheaper. It has been singled out by investors as the biggest threat to the ECB’s efforts to revive inflation.
Officials noted that easy financing conditions “could not be taken for granted” and depended on the ECB’s own policy stance, minutes of the meeting showed on Thursday.

Last week, US investment bank Morgan Stanley said the euro could hit parity with sterling by the end of next year – which would be unprecedented.
Minutes of the ECB’s policy meetings provide details of the discussion without saying who said what. The board that discusses interest rate setting includes the heads of each euro area central bank and top officials from Frankfurt.

The latest minutes show rate-setters were highly aware of the risk of euro appreciation as they decided against any change to their pledge for continued monetary stimulus.
“Concerns were expressed about a possible overshooting in the repricing by financial markets, notably the foreign exchange markets, in the future,” the ECB said in the accounts.

“It was underlined that the still favourable financing conditions could not be taken for granted.”
The policymakers also said the duration and pace of the ECB’s €2.3 trillion bond-buying programme were not the only available levers to adjust their stance and “more policy space” was needed “in either direction”.

The minutes showed a suggestion was made to adjust the ECB’s guidance to the market, which at the moment includes a pledge to increase bond purchases from their current €60bn monthly pace if needed. Changing the language would be seen as an indication that the more likely scenario is for QE to be eased off than increased, but it was dismissed out of fear of a market backlash.
Meanwhile, analysts at UBS think sterling may be undervalued. The pound has been sandwiched between the world’s two biggest currencies since the start of the year, making it hard to gauge how markets perceive the UK as Brexit negotiations progress. While sterling has gained nearly 5pc against the dollar, it has fallen 6pc versus the euro – a trend that might be about to reverse, according to UBS Wealth Management.

If true, it will be bring relief to Irish exporters. (Additional reporting Bloomberg / Reuters)

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