Wary of euro rise, European Central Bank mulls more stimulus

AP News
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Posted: Oct 21, 2015 10:29 AM
Wary of euro rise, European Central Bank mulls more stimulus

FRANKFURT, Germany (AP) — The European Central Bank is edging closer to unleashing more monetary stimulus on top of the 1.1 trillion euros ($1.2 trillion) it is already pumping into the eurozone's less than impressive economic recovery.

While no immediate action is expected at Thursday's meeting in Malta, investors will look for hints from ECB President Mario Draghi that the bank is willing or preparing to extend the stimulus effort rather than let it end next year.

A big concern is preventing the euro from rising from its current level around $1.13 per euro. A higher euro hurts exporters, who are key contributors to growth and jobs, and tends to weaken inflation by weighing on import prices.

A currency tends to weaken as a side effect of monetary stimulus, whose primary aim is to raise consumer price inflation. Currently, the eurozone's inflation rate is alarmingly weak at an annual minus 0.1 percent. Europe's economy grew 0.4 percent in the second quarter but unemployment remains high at 11 percent.

Draghi is getting no help on the exchange rate from his counterparts across the Atlantic at the U.S. Federal Reserve. The Fed has sent the dollar lower by postponing its first rate increase in seven years. It has held rates near zero as the economy recovers from the financial crisis and recession that followed the collapse of U.S. investment bank Lehman Brothers, way back in 2008.

Higher interest rates in the United States would draw more investment into dollar-denominated investments, increasing demand for the dollar and boosting its exchange rate against other currencies. So when the Fed backed off a rate increase at its September meeting, it put some upward pressure on the euro versus the dollar. The euro has slid back a bit this week from as high as $1.1474, but possible appreciation remains a worry. Many market participants think the Fed now won't raise interest rates until next year.

The ECB, the chief monetary authority for the 19 countries that use the shared euro currency, is currently making monthly purchases of government and corporate bonds using newly created money. The purchases are slated to run at least through September 2016. But Draghi and other ECB officials have indicated that the stimulus effort could be extended beyond that if inflation doesn't show signs of turning up.

Marco Valli, chief eurozone economist at UniCredit Research, thinks the ECB won't announce more stimulus until the first months of next year. On Thursday, he said, Draghi will try to keep a lid on the euro by making clear that more stimulus could be coming.

"We expect no action and dovish rhetoric, mainly intended to stem the euro appreciating trend," Valli wrote in a research note. "Dovish" means inclined to loosen monetary policy, whether through lower interest rates or more stimulus.

The ECB has already cut its benchmark interest rate to 0.05 percent and has said that is as close to zero as it can get, so attention is focused on its stimulus program. That consists of buying bonds with freshly created money, effectively pumping cash into the banking system in hopes it will encourage lending and borrowing, and thus boost the economy.

The Fed, Bank of England, and Bank of Japan have all carried out such purchases, with mixed results. The U.S. and British economies have shown stronger growth, and U.S. unemployment has fallen. But the global economy continues to show signs of weakness, such as a drop in prices for fuel and other commodities and low market interest rates.