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03/12/2016

France scores points in fight against strong euro currency

Euro & Finance

France scores points in fight against strong euro currency

Drachma euro notes Greece.JPG

The European Central Bank (ECB) is holding its monthly meeting today (6 February) amid growing calls to lower the bank's refinancing rate to zero, EurActiv.fr reports.

Calls for an expansionist monetary policy come amid warnings that the eurozone economy is showing signs of deflation.

Inflation reached 0.7% in January, well below the ECB's 2% target.

Real interest rates are already negative since the ECB's main rate, 0.25%, is lower than the average inflation rate in the euro area.

Under these conditions, banks are theoretically driven to put their cash in the private sector rather than the ECB. If they put it in the ECB, they are “taxed”, and forced to pay for depositing their money in the Frankfurt-based institution. This means that only risk-taking is remunerated, followed by loans to individuals or businesses and government debt, which represents the lowest risk.

A tool to be handled with care

The euro showed signs of weakness ahead of the ECB meeting, hitting a low against the dollar this week, suggesting that the market expects an easing of monetary policy.

But Ken Dickson, director at Standard Life, says real interest rates is a tool that must be handled with care.

“The implications for a currency which has a negative main interest rate are serious: investors holding euros will tend to seek another currency,” he warns.

In the past, negative real interest rates have resulted in a devaluation of the currency, including the yen in the 1990’s or the pound sterling in 2009.

This is not always the case, however. With the euro, it seems stability itself is attractive to investors. Since 2010, the currency has hardly fluctuated and remained between $1.20 and $1.40. Nowadays, with the emerging countries’ economies faltering, the euro could still be seen as a haven, even with a negative real interest rate.

Some economists believe however that monetary policy is now the only solution left to fight deflation, which is settling everywhere except Germany, according to Patrick Arthus, research director at Natixis.

France opposed to a strong euro

In France, many see depreciation as the only way out, with Industry Minister Arnaud Montebourg leading calls for a weaker euro.

The French Economic Analysis Council (EAC), an advisory body, shared the same view in a January study sent to the prime minister Jean-Marc Ayrault.

The authors believe the ECB's current policy is not expansionary enough, as the unemployment rate is high and the credit market remains highly fragmented.

Lowering rates is not the only option since the ECB can also intervene on financing of SMEs for example.

The EAC estimates that a 10% depreciation of the euro would boost exports by up to 11% of the area's GDP. The impact on imports is uncertain however, it says.

Households and business would lose purchasing power, notably on petroleum products, but the GDP would increase by 0.6% over one year and 1% after two years, the EAC predicts.

The authors of the study believe that the euro is not overvalued today, but that the economic situation calls for a more expansionary monetary policy.

Background

The European Central Bank (ECB) is the central bank for the eighteen EU countries which have adopted the bloc's common currency, the euro.

The ECB's main task is to maintain price stability in the euro area, below 2% of GDP.

The ECB president plays a vital role in deciding the monetary policy of the euro area. He is assisted by the executive board of the ECB, composed of himself, a vice-president and four other board members.

The ECB's board is part of the Governing Council of the bank, which is made up of all 18 presidents of the national central banks of eurozone member states. The body usually meets twice a month in Frankfurt, where the ECB's seat is located.

Timeline

  • 6 February : meeting of ECB's governors council