Falling euro cause for celebration and concern

The Euro reached its lowest point against the dollar for nine years this week.

Eine Studie zeigt, dass die USA die größte Steueroase sind. [Dennis Skley/Flikr]

European manufacturers are happy with the falling value of the single currency, which allows them to export their goods more easily. But the mood is tempered by the threat of deflation, particularly harmful to indebted countries, and increasingly a worry for the ECB, which may begin a policy of buying up sovereign debt from 22 January. EURACTIV France reports

The dramatic devaluation of the euro, from 1.36 to 1.18 dollars since July 2014, is seen by some as a cause for celebration.

For exporting manufacturers, the decline of the single currency has had a windfall effect. The CEO of Arianespace, Stéphane Israël, welcomed the development at a press conference of rocket manufacturers on Tuesday 6 January, saying “bravo to Mario Draghi, bravo to the European Central Bank, because this monetary policy allows us to compete on an equal footing”.

Stéphane Israël had previously served as cabinet director for Arnaud Montebourg, the former Minister of Industrial Renewal. 

>> Read: EU’s competition rules ‘stupid and counter-productive’, Montebourg says

To counter the risk of deflation, Mario Draghi, the President of the ECB, may employ tactics similar to those used by the US Federal Reserve, namely to provide massive, cheap liquidity injections in the hopes of revitalising the economy.

Benefits to competitiveness

At a time when the ECB appears to be moving towards a policy of quantitative easing, the Fed is taking the opposite approach, and is likely to put up interest rates this year. The collision of these two monetary policies could further devalue the euro against the dollar, which is already at its lowest point in nine years.

“One of the competitive advantages we have over our American friends today is simply the euro-dollar exchange rate,” the director of Arianespace said, referring to SpaceX, the company’s American competitor.

Louis Gallois, the CEO of aerospace and defence company EADS, the parent company of Airbus, said that a 10 cent rise of the euro against the dollar would wipe out 2% of the group’s profit margin.

Stéphane Israël added that “each time the euro falls, the competitiveness of Ariane grows, and it is a very, very good thing that the European currency offers this support to Europe’s economic recovery”.

Worries over deflation

The devaluation of the euro was clearly one of the ECB’s objectives, but in the absence of growth and inflation, the ECB will be forced to draw out its policy of monetary easing in 2015.

The governors of the Central Bank will discuss their options for buying sovereign debt, a method known as quantitative easing, at a meeting on 22 January. The buying and cancellation of sovereign debt is a practice that has been widely used in Japan and the United States since the crisis, but never before in Europe, where it is increasingly seen as a necessary measure.

The effect of deflation in the eurozone would be particularly damaging to the severely indebted European countries, such as France, Italy, Spain and Greece. Just as inflation alleviates debt, deflation increases its value. The phenomenon of a long-term decline in prices can cause consumers to sit on their money in the hope of lower prices to come, depressing the dynamism of consumption, investment and consequently, economic growth.

Buying government bonds a priority

According to the Dutch newspaper Het Financieele Dagblad, citing unidentified sources, the European Central Bank is studying three options for buying sovereign debt ahead of their monetary policy meeting on 22 January.

The first option unveiled by the Dutch paper is to inject liquidity into the system by allowing the ECB to buy government bonds in proportion to the contribution of each member state to the capital of the Central Bank.

The second option under consideration is for the ECB to purchase only triple A rated debt, with the aim of pushing other investors towards the riskier government and corporate bonds.

The third option is similar to the first, but with the national banks, not the ECB, buying the debt. This would place the risk in the hands of the country in question, according to the paper, not the Central Bank itself.  

The ECB has declined to comment.

>> Read: Top German court refers ECB bond-buying case to EU judges

The European Central Bank lowered its interest rate to below zero in June last year, reflecting concerns about the euro zone's stagnating economy.

>> Read: ECB cuts rates below zero to boost recovery in the eurozone

The ECB is very concerned about inflation in the eurozone, and has always pursued a rigorous monetary policy that impacts on the exchange rate of the single currency.

While the United States follows a more lax monetary policy, the euro tends to appreciate in value, penalising European exporters.

On 4 September 2014, the base rate of interest, the rate at which the ECB lends to other banks, was once again lowered from 0.15% to 0.05%, demonstrating a new policy direction. 

>> Read: ECB rate cut boosts Spanish, Italian yields

22 January: meeting of the governors of the ECB

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