2017 was a good year for the euro. 2018 may prove to be the same. A further appreciation in the value of the euro might not necessarily be what policymakers in the currency bloc have on their wish list for the New Year. Yet a combination of euro tailwinds and US dollar headwinds could nevertheless produce such an outcome.
The problem for euro-zone officials is that while greater demand for the euro reflects renewed investor confidence in the currency, its rise also makes goods imported into the bloc cheaper in local currency terms, complicating the European Central Bank’s efforts to foster inflation that is close to but below 2 per cent.
The euro zone is experiencing a “super-charged economic expansion,” wrote Shweta Singh, director of global macro at London-based TS Lombard in mid-December. That expansion surely owes much to the ECB’s continuing attempts to kick-start inflation via its adherence to ultra-accommodative monetary policy settings.
With the good economic news from the euro zone seemingly broad-based, why wouldn’t investors want a piece of that euro-denominated action?
The flash euro zone composite purchasing managers’ index has “surged to 58.0, the highest since 2011,” TS Lombard wrote, with the manufacturing sector “leading the bounce, strengthening to 60.1 which is the most optimistic reading on record.” With the good economic news from the euro zone seemingly broad-based, why wouldn’t investors want a piece of that euro-denominated action?
ECB monetary policy may now be too loose for the euro-zone economy.
“We would definitely be positive if the ECB would ease up on the very aggressive monetary policy it has right now,” Denmark’s finance minister, Kristian Jensen, said on December 20. “The buying of bonds is very aggressive in my view, especially looking at the condition of the European economy.”
Of course Denmark is outside the euro zone, but with its currency effectively pegged to the euro, Danish monetary policy has to mirror the ECB. Indeed, even though the Danish economy is in an upswing its own benchmark deposit rate is minus 0.65 per cent, with the ECB’s deposit rate at minus 0.4 per cent.
Given the strength of the data, markets may conclude the ECB will have to withdraw monetary accommodation more quickly than is presently expected.