Cœuré Bears Down on Strong Euro Exchange Rate

Above: Benoit Cœuré, Executive member of the ECB.

The ECB's Benoit Cœuré increases scrutiny on the rising Euro and reminds traders that the central bank might be less accepting of any further advances.

Last week Mario Draghi appeared to strike an apparently complacent note on the impact of the appreciating Euro which some in the foreign exchange market took as an effective green-light to further strength.

The debate on the Euro has taken another turn after one of Draghi's European Central Bank (ECB) colleagues, Benoit Cœuré raised the issue in a speech in which he mentioned the exchange rate 48 times.

Coeuré's argument is the deflationary effect of the appreciating Euro could be offset by strong domestic growth, which in turn could be fostered by an environment of continued loose monetary policy. 

In short - the ECB might be able to delay its intention to raise interest rates and end the quantitative easing programme in light of the stronger Euro. The whole reason for the Euro's 2017 rise has been expectations for such a move.

Following his comments, not surprisingly, the Euro made losses and fell as much as 0.4 percent on the day to trade at $1.9935. The Euro meanwhile continued to extend losses against the Pound, with the GBP/EUR exchange rate closing above 1.1015.

"Overall, we think the ECB is comfortable with the strength of the euro we have seen up until now, but will not welcome significant further appreciation. As such, a very gradual exit from the QE programme still looks likely," says Nick Kounis at ABN AMRO.

Kounis notes that on first glance, the speech seems hawkish, as it makes the case that the euro has less impact on inflation than in the past.

On the other, he also argues that one reason to expect less impact is that monetary policy will remain accommodative for longer.

"In addition, he warns that future exchange rate appreciation could have a more significant impact. So the speech is more balanced on closer inspection," says Kounis.

The surprise remarks signaled that, "clearly, the central bank is not indifferent to the exchange rate," according to the FT's Katie Martin.

Cœuré acknowledged the Euro was a major factor in determining inflation, something which would be made clear by simply  “eyeballing” the level of the Euro overlaid with inflation, and noting  “a pass-through of around 40%”.

However, "there are occasions when euro area core inflation rises, rather than falls, following an exchange rate appreciation – which is entirely at odds with our traditional thinking on the pass-through," said Coeure.

He went on to add that this is, "typically the case when the exchange rate appreciates in response to a favourable demand shock."

By "demand shock" he meant a rise in domestic growth, or when the economy is operating at above capacity, and inflationary pressures emerge that "are sufficient to offset the disinflationary effects coming from the exchange rate channel."

Cœuré went on to say that as these examples show it is the state of the economy which determines the real impact of the exchange rate on inflation.

"The end result: with policy being effective in boosting growth, any disinflationary effect of a stronger currency arising from expectations of a tighter future monetary policy stance might be mitigated, or offset, by the ensuing improvement in the economic outlook," added the ECB board member, who appeared to be advocating a much more dovish stance.