(Reuters) – Grappling with an ailing euro zone economy and stagnant prices, the European Central Bank is hoping that help will come from something it cannot control: the value of the euro.
As Washington prepares to stopper the supply of cheap money that has been helping it revive the United States, the euro has started to fall steeply against the dollar.
And that’s just how the ECB likes it.
With prices in Europe rising at their slowest in five years and its economy stubbornly dormant, Frankfurt is starting to use similar tactics to those used by the Federal Reserve – pumping cheap money into the system in the hope of awakening it.
But those efforts have at best an uncertain outcome. Now, however, the divergence of approach on either side of the Atlantic has presented the euro zone with an alternative that works – a weaker currency.
“The one sure-fire way to get things moving is to get the exchange rate down,” said RBS economist Richard Barwell. “It’s the best antidote to disinflation known to man.”
A falling euro EUR= would drive up prices by making goods from abroad, whether cars or clothes, more expensive. It would also boost exports, cutting slack as companies work harder to meet demand. That in turn could bring a rise in inflation toward the ECB’s target of just under 2 percent – one of the building blocks for economic prosperity.
Last month, euro zone inflation slowed to just 0.3 percent.
ECB President Mario Draghi has been at pains to stress that the central bank does not have an exchange rate target – eager to avoid antagonizing the United States and other big economies with ‘beggar-thy-neighbor’ tactics.
But last week Draghi dropped a hint that Europe’s different position could be beneficial, noting “significant and increasing differences in the monetary policy cycle between major advanced economies.”
For financial markets, this amounted to tacit encouragement to push down the euro, already trading close to 2-year lows.
Britain provides useful clues as to what might happen next.
A sharp drop in sterling’s GBP= exchange rate against the dollar just before the financial crisis set in – from above $2.00 in mid-2008 to around $1.35 in early 2009 – fed through quickly. Consumer prices bounced from 1.1 percent in September 2009 to 5.2 percent two years’ later – in large part due to the currency effect.
That evidence makes many officials in Kaiserstrasse, the Frankfurt address of the ECB, quietly optimistic, given the currency has dropped from nearly $1.40 in May to around $1.26 now.
Last month, the ECB published a report exploring “an alternative path for the euro” – a fall in its value to $1.24 by 2016 that is well on the way to becoming reality.
That would increase the euro zone’s 8.5 trillion euro economy by up to 0.3 percent next year and in 2016, and in turn lift the bloc’s price inflation, the ECB’s primary benchmark of health, by up to 0.3 percent – doubling the current rate.
Some predict an even steeper drop, and implicitly, a greater boost to the economy. Deutsche Bank forecasts that one euro could be worth less than a dollar by late 2017.