One of the biggest FX movements of late was the devaluation of the Japanese yen. The sharp move, which was blessed by Japanese authorities, eventually triggered some comments by European officials. Will Europe also try to devalue the euro? Probably not.
The new government in Tokyo vowed to fight deflation and to boost Japanese competitiveness. The pressure from the government pushed the Bank of Japan to announce more and more quantitative easing, and to lift the inflation target. Japanese officials wanted a weaker yen, and eventually got it, but they keep saying that the move is only a correction.
On the other side of the globe, there is another struggling zone: the euro-zone. Now officially in recession, a stronger euro against the dollar and the yen makes European exports less competitive, making a return to growth even harder.
Luxemburg’s Prime Minister Jean-Claude Juncker said that the euro is “dangerously high”. A softer version of his comment was heard by German Chancellor Angela Merkel, and also French president Françios Hollande said that the value of the euro is “significant”.
These complaints may reach the Group of 20, but will likely remain verbal complaints, not accompanied by any action. Why?
The key to weakening the euro lies within the realm of the European Central Bank, which is not so eager to act. The German central bank, Bundesbank, has inflation on its mind, and a higher currency value means lower inflation. The Bundesbank already allowed for the OMT – a program to buy bonds in the secondary market, under specific conditions. Fortunately for the Bundesbank, this program has not been activated yet. However, measures to directly devalue the currency would be unacceptable.
In addition, the ECB is actually moving in the opposite direction: various euro-zone banks are repaying the LTRO loans. The Long Term Refinancing Operations are cheap loans from the ECB to banks, meant to quickly supply the markets with liquidity. In some cases, they were used to buy peripheral bonds, thus serving as indirect QE.
With some euro-zone banks paying back some of these loans, we actually see monetary tightening in the euro-zone.
The ECB hopes that the improving conditions in the financial markets will eventually impact the real economy, enabling Spain and Italy to return to growth. With growth, it will be easier to balance the budgets, even with a higher currency value.
However, these economies are suffering quite badly, and a blow to competitiveness from the euro’s exchange rate joins terrible unemployment rates and austerity measures.
For these countries, hope for a weaker euro does not come from the ECB, but rather from the stronger economies of the world: a faster recovery of the US will increase demand for European goods and will also strengthen the US dollar. The same goes for other countries: stronger demand from other countries will help the European recovery more than the zone’s central bank.
Further reading: Euro to usd forecast.