Trading at 1.18/1.19 to the dollar, the euro has become a pricey currency. But the European currency has also gained against all other currencies as its effective exchange rate has returned to levels unseen since the end of 2014. So we can no longer count on the euro losing value. This makes the ECB’s job harder as a strong euro allows for importing disinflation, thereby pushing back the chances that inflation in the euro area will swiftly converge towards the 2% target set by the central bank.
We can make three initial remarks on this situation.
The first is that the euro’s swift rise looks like a monetary restriction. Monetary policy has become more restrictive and the ECB’s stance must confirm its aim for accommodation in the long term so as not to increase potential expectations on a change in course. The second remark is that a strong euro is coherent with the euro area’s very high external surplus. The decline in the euro was not compatible with this surplus. The last remark is that the dollar is weak. Its effective exchange rate is at its lowest since the end of 2016: America is not doing well.
Following on from these three remarks, we can derive three explanations to understand this currency movement. Continue reading