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Euro's Weakness Under the Spotlight at ECB
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Euro's Weakness Under the Spotlight at ECB
Mar 22, 2024 2:18 AM

"The euro/dollar rate that has fallen substantially in the last few weeks, which obviously has a bearing on inflation going forward. So it's on the basis of that set of monetary-policy-stance related elements that we have taken the decision," ECB President Christine Lagarde.

© European Union, reproduced under CC licensing

The Euro to Dollar exchange rate's July slide was cited by the European Central Bank (ECB) as a key influence on its thinking about inflation this week and as a driver of its decision to call time on the era of negative interest rates with a larger than expected increase in its main benchmarks for borrowing costs.

July's fall from above 1.04 against the Dollar was seemingly among the factors that prompted the ECB to favour the larger than anticipated increase that raised its commercial bank deposit rate back to zero on Thursday.

"The reason we decided, by total consensus around the table, to depart from the signal that we had given back in Amsterdam, was twofold. Number one, we had clear realisation of upside risk to inflation. And I can give you a list of those examples," President Christine Lagarde said in the July press conference.

"And added to that, which relates, essentially, to inflation, the euro/dollar rate that has fallen substantially in the last few weeks, which obviously has a bearing on inflation going forward. So it's on the basis of that set of monetary-policy-stance related elements that we have taken the decision," she later added.

Thursday's decision spurred the Euro into a further attempt at reversing the decline that saw it trading briefly below parity with the Dollar last week, which was prominent among the influences galvanising the Governing Council.

Above: Euro to Dollar rate shown at hourly intervals.

The ECB has often said in the past that it does not target exchange rates with its monetary policy, although that was never the same as saying that it doesn't pay attention to them and nor was it the same as saying that it wouldn't sometimes take them into account in the pursuit of its inflation target.

However, if ever there was cause for any doubt, President Lagarde was unambiguous when placing EUR/USD under the spotlight in this latter sense.

"We expect inflation to remain undesirably high for some time, owing to continued pressures from energy and food prices and pipeline pressures in the pricing chain. Higher inflationary pressures are also stemming from the depreciation of the euro exchange rate," President Lagarde also said.

July's fall added to what was an already steep 2022 decline that will raise the cost of imported goods including energy and fuel, making it an important influence on the outlook for inflation, economic growth and interest rates.

Above: Euro to Dollar rate shown at 4-hour intervals.

With the ECB now associating developments in the exchange rate with its deliberations on monetary policy, the bank and single currency may be on the cusp of becoming limiting factors for those in and around the market who've bearish views on the Euro-Dollar outlook.

The Euro to Dollar rate was still carrying a loss of more than 10% for the 2022 year-to-date on Friday but could now find itself better supported, if not endowed with some corrective potential, given the latest central bank developments on both sides of the EUR/USD equation.

This is after some Federal Reserve (Fed) officials suggested last week that June's inflation figures hadn't swayed them in favour of lifting U.S. rates at a faster pace, forcing the markets to rethink bets that there was an emerging risk of a full percentage point increase this month.

It also follows potentially pertinent remarks from Fed Chairman Jerome Powell during a panel discussion at the ECB's annual conference on central banking last month, which indicated a degree of indifference to the disinflationary tailwind whipped up by the strong Dollar during the last year or more.

"It’s just another financial condition to us and since our economy, the external sector of our economy is so much smaller than it is for the others here, it’s not that important. The Dollar has been strong and that would be disinflationary but only at the very margin," Chairman Powell said in June.

Above: Euro to Dollar rate shown at daily intervals.

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