Alexandre Garabedian,

The Agefi

PARIS (Agefi-Dow Jones)--Mario Draghi had repeatedly said it during his term at the head of the European Central Bank: the ECB does not target the exchange rate of the euro. In practice, the institution keeps a close eye on developments in the single currency, and its recent rise would begin to worry some members of the Governing Council, who spoke to the Financial Times on condition of anonymity.

Its chief economist Philip Lane even cracked a statement -- "the euro-dollar rate matters" -- to ease the pressure. It was against the greenback that the movement appeared the most spectacular, with a jump from 1.12 to 1.20 between mid-July and early September, a psychological threshold briefly crossed that corresponds to the long-term equilibrium exchange rate between the two currencies.

"Good reasons"

Normally, such a rapid increase would be problematic for an export-oriented region. A 10% appreciation of the euro's trade-weighted exchange rate would cut gross domestic product (GDP) and inflation by about one point after two years, according to the economic literature and a recent Study by Goldman Sachs. But as Isabel Schnabel, a member of the ECB's Executive Board, recalled in an interview with Reuters on 31 August, the rise is primarily for good reasons. It signals an improvement in growth prospects and a return to investor confidence after the historic agreement reached in July on a European recovery plan.

"Let's be careful not to interpret exchange rate movements in isolation, because research shows that if there is a depreciation of the US dollar, it tends to boost global trade and global growth," Schnabel said. For his part, Simon Wells, Chief European Economist at HSBC, places these movements in a context that is not conducive to the growth of global trade, and not only because of Covid-19: "Growing protectionism and relocation are becoming a much more important factor than the exchange rate. This is why euro area countries, especially Germany, are relying more on domestic demand and fiscal policy to support the recovery."

Assuming that the 10%-1% rule between exchange rates and growth holds, the rebound of the single currency would in any case have a modest impact compared to the strong GDP growth expected mechanically in 2021.

The impact on inflation is just as difficult to gauge, but would be relatively stronger given the weak starting point. Ecb economists were due to revise their copy on 10th September after having reduced their underlying inflation forecast for 2022 before the summer from 1.5% to just 0.9%.

Since the ECB's pre-summer projections, the euro has appreciated by almost 10% against the greenback and by 5% in trade-weighted terms. But in return, we must take into account the revaluation of oil prices, which appreciated by 65% over the period to about $ 45 per barrel of Brent, and by 50% when expressed in euros. The effect of the temporary reduction in VAT in Germany, from 19% to 16% on 1 July, will also fade in a year and will then mechanically raise the price index in the second half of 2021.

Digging into the toolbox

With such a low inflation outlook, a level of the euro that could become worrying and a strategic review whose conclusions have been postponed to 2021, the ECB would have no choice but to dig back into its toolbox.

Beyond verbal interventions, several economists are waiting for December for an extension of the emergency asset purchase program launched during the pandemic, the PEPP. However, such an announcement would probably reduce yield spreads between eurozone government bonds, and a decline in the spread is correlated with a strengthening of the euro, says Kit Juckes, strategist at SG. Another possible option is a further rate cut, but which should be accompanied by an easing of "tiering", in order to exempt a larger share of banks' excess reserves from negative rates. In short, at a time when the Federal Reserve has embarked on a historic inflection of its mandate, which favors the weakening of the dollar, the ECB is preparing a studious return.