News Column

Euro's Rise, Currency War Risk Overshadowing ECB Meeting

Feb 5, 2013

Andrew McCathie

The European Central Bank meets Thursday with the new positive mood in the debt-hit eurozone overshadowed by the threat posed to the region's recovery by the rise in the euro, a possible global currency war and renewed political uncertainty.

The ECB's rate-setting council is expected to announce Thursday that it left interest rates on hold at an historic low of 0.75 per cent following a pickup in key economic indicators for the 17-member eurozone.

"With the positive trends observed ... continuing, we think that (ECB chief Mario) Draghi will be content to stay on the sidelines," said Jennifer McKeown, senior European economist with the research group Capital Economics.

Since the bank's last meeting about four weeks ago, nations at the centre of the debt crisis such as Spain and Italy have successfully launched a series of bond auctions.

At the same time, global shares have turned in strong performances amid hopes that the worst of the eurozone debt crisis might be over.

The Markit research group said on Tuesday its Purchasing Managers' Index for the eurozone's manufacturing and services sectors climbed to a 10-month high in January.

"The level of economic activity is in the process of stabilizing at very low levels," Dragi told the Davos World Economic Forum last month. "We see a recovery in the second half of the year. All the indices point to substantial improvement of financing conditions."

Annual consumer prices also tumbled to 2 per cent last month, bringing inflation into line with the ECB's 2 per cent target.

This gives the ECB some room to move if the recovery in the eurozone should falter later in the year.

But last month the Bank of Japan unveiled a more expansionary monetary policy aimed at spurring the Asian powerhouse's recession-bound economy with a weaker yen helping boost the nation's export machine.

This prompted concerns from monetary authorities around the world about the risk that the Japanese monetary authorities' action might reduce the competitiveness of other leading currencies, consequently paving the way for a currency war.

The result has been to send the euro higher and as a consequence threaten to undercut demand for the eurozone's exports.

The euro climbed to 1.3710 dollars on Friday - its highest level in more than a year - underpinned by cautious optimism about the outlook for the eurozone and a weaker yen.

Fears of a stronger euro could not have come at a worst time for the eurozone, where there a few signs that the improvement in economic sentiment indicators has spilled over into the real economy.

Analysts expect Draghi to shrug off questions at his regular press conference Thursday about the risks posed by the euro's appreciation and the threat of a global currency war.

"Draghi will probably stick to the usual mantra that the ECB does not target exchange rates, but responds to foreign exchange fluctuations if and when they have the potential to impact medium-term risks to price stability," said Marco Valli, chief eurozone economist with the Italian bank UniCredit Research.

But since the start of the week investor concerns about political uncertainty in the eurozone have re-emerged leading to a spike in borrowing costs in Italy and Spain.

This followed a growing corruption scandal facing Spanish Prime Minister Mariano Rajoy as well as the publication of polls pointing to an unpredictable election result later this month in Italy.

The ECB meeting also coincides with the launch of a fresh attempt in Brussels by European Union leaders to reach agreement on the new EU budget.

While the euro and European shares rebounded on Tuesday from steep falls on Monday, analysts say eurozone financial markets could come under renewed pressure in the event of more bad news from Italy and Spain, which are also the eurozone's third and fourth biggest economies.

Source: Copyright 2013 dpa Deutsche Presse-Agentur GmbH

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