ECB ready to counter the rise of the euro?

European Parliament. Committee on Economic and Monetary Affairs (ECON) meeting. Hearing with Mario Draghi, President of European Central Bank and head of the European Systemic Risk Board. In the chair of the ECON Committee, Sharon Bowles. Draghi trying to improve his vision by adjusting his glasses. (EP Audiovisual Services, 3.3.2014)

As expected by many, the European Central Bank left its basic interest rate unchanged at 0.25%. However, Mario Draghi, the President of ECB, raised the tone of the central bank’s readiness to confront possible unfavorable developments in the money markets. Presumably he has in mind the risks which may arise in international money markets, from the American monetary policy tapering and the reversal of quantitative easing.

The gradual capital outflow from the developing economies that has already started, may take wider dimensions as a result of this reversal of the US central bank’s, the Fed’s, monetary policies, that is from the utmost relaxation passing to a less accommodative stance. Already the currencies of large developing countries like India, Brazil, South Africa and Turkey, even the Chinese yuan are losing large or smaller parts of their foreign value and their interest rates are rising.

In view of that, Draghi stressed that “We are monitoring developments on money markets closely and are ready to consider all instruments available to us. Overall, we remain firmly determined to maintain the high degree of monetary accommodation and to take further decisive action if required”. This is the first time that Draghi correlates the possible developments in money markets with the “instruments available” to the ECB. Obviously, within those instruments the most important is liquidity. He even took one more step towards possible additional monetary accommodation, this time related not to internal Eurozone developments but to international money markets. This sounds like the ECB trying to arrest the rise of the euro.

Something changed this month

Draghi further clarified that by saying “…and to take further decisive action if required”. It won’t be just action then, but it will be decisive action. This is probably the first time that the ECB leaves the door open to taking the lead from the American Fed in supplying the western financial markets with additional liquidity and through them the developing world with something like a euro substitute to dollar drying up liquidity.

Last month Draghi had also touched upon this issue. In his introductory statement in the press conference of 6 February he noted, “Developments in global money and financial market conditions and related uncertainties, notably in emerging market economies, may have the potential to negatively affect economic conditions”. Then he was asked about the possible negative effects on Eurozone’s exports from “emerging markets’ foreign exchange volatility“ and the measures the ECB could take in order to deal with that threat. His answer was very telling seen under the light of yesterday’s statement. He had answered then that “Thus far, we have been watching these developments. Thus far, the euro area economy and euro area financial markets have shown a great deal of resilience with respect to these developments”. It seems that now this has changed.

Decisive action

In short, what Draghi said yesterday is tantamount to ECB’s being now ready “to take decisive action if required”. Seemingly, the ECB has now monitored a transmission of the developing countries foreign exchange volatilities (devaluation) to their interest rates (rising) which will affect economic activities there, with negative repercussions on Eurozone exports to those huge economies. Last month Draghi had said that “The reasons for the current situation in the emerging market economies are quite complex and certainly outside the control of euro area policy-making authorities or certainly outside that of monetary policy”.

Yesterday though, he noted that the ECB is ready to react to money market volatility. The difference with last month is very obvious. Specifically, he said “Developments in global money and financial market conditions and related uncertainties, notably in emerging market economies, may have the potential to negatively affect economic conditions”. Last month he had said something different, “Thus far, we have been watching these developments (the situation in emerging markets). Thus far, the euro area economy and euro area financial markets have shown a great deal of resilience with respect to these developments”.

When will be the right time?

Understandably the Eurozone is not any more that resilient vis-à-vis the developments in emerging markets. The problem is that the anemic growth rate of Eurozone, which oscillates between 0.1% and 0.3%, depends entirely on exports. If the emerging markets start having severe financial problems with currency devaluations and rising interest rates, their imports from Eurozone may decrease sharply and send the euro area again to recession.

The problem is if the monetary measures that the ECB has in its arsenal can effectively confront those negative prospects. In any case Draghi said that the ECB is ready to take extraordinary measures if required. Understandably if those measures are to support the exports, Germany might agree. But what if Berlin says it’s not yet the right time, let’s wait some months! Will the ECB accept the new Teutonic challenge and see the unemployment percentages start a new upwards course and real deflation ravaging Eurozone?

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