Research: Draghi Will Not Join 'Currency War'‏

The ECB is out of sync with the other central banks. The uptrend in EUR/USD will continue in the coming months, even though Mario Draghi managed to halt the strengthening of the euro at the press conference in February.

Draghi has highlighted the stronger euro as a downside risk on growth and inflation, and said that the ECB will assess whether the euro performance has changed the outlook for price stability.

Even though further appreciation of the euro will have a negative impact on growth and inflation, there is a lagged positive effect from the previous years' depreciation. These contributions will eliminate the negative effect on growth and inflation in 2013.

We expect the ECB to keep rates unchanged and refrain from further easing as long as the outlook for a slow recovery remains and the EUR/USD stays close to our forecast of a peak at 1.38 in 2013.

Further strengthening of the euro in coming months
The euro has strengthened since summer 2012 and at the beginning of February, the EUR/USD pair reached its highest level in 15 months. The appreciation is largely the result of the ECB being out of sync with its de facto monetary policy tightening at a time when other major central banks are easing. Following an intensified debate about the currency war, the ECB’s February press conference saw Draghi once again mastering verbal intervention as – with a very balanced tone – he mentioned the strengthening of the euro as a downside risk to inflation. He also indirectly hinted at the euro performance when speaking of downside risks to growth, as he now also sees these as stemming from the possibility of weaker-than-expected exports. Since global growth data has generally improved, it is hard to see this other than a risk from a stronger euro. All considered, he left the door open for future ECB actions. Markets responded by weakening the EUR/USD pair from 1.355 to 1.34 at the end of the European trading session.
We do not think the uptrend will be reversed. There are still several factors supporting the euro, such as continuing global recovery, more safe-haven flows back in the euro and other major central banks still favouring a historically loose monetary policy. Consequently, the euro can be expected to continue its uptrend on a 6M horizon and peak at 1.38. In light of this, it could be that Draghi will respond to the performance of the euro as it will affect inflation.

Draghi: ‘Strengthening downside risk on growth and inflation’
The big question is whether the appreciation will trigger an ECB response. In order to assess this, we have estimated how the strengthening of the nominal effective exchange rate affects GDP growth and inflation.

Effect on growth: The currency appreciation will deteriorate price competitiveness which will reduce exports, and raise imports thereby lowering domestic output. Even though there will be a negative effect on growth of strengthening in 2013, previous years’ currency depreciation will have a lagged, positive effect on growth.

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