Currency Controls

Lower Euro Helping in Short Run, But Inflation Awaits

euro dollar ap
These days it's the dollar that's moving up against the euro.
  • Why it matters

    Why it matters

    Business owners and politicians advocate depreciating the euro to improve export prospects for European companies harmed by a strong common currency, but rising inflation could offset gains in the long term.

  • Facts

    Facts

    • The euro is expected to continue its decline against the dollar in the coming months, with analysts on average predicting a rate of $1.28 per euro by the end of 2015.
    • U.S. bonds are attracting more investors, helping the greenback’s value.
    • Success is possible even with a strong currency, as demonstrated by German companies.
  • Audio

    Audio

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The situation is clear for Manual Valls. “The European Central Bank has to go even further,” the French prime minister said recently. What he means by going further is that the ECB has to additionally devalue its common currency, the euro, which will help the economy in the euro zone.

Mr. Valls has advocated a weakening of the euro for months, and many agree with him. Politicians in France and the southern European countries have long complained that the common currency is smothering business. Their argument: The stronger the euro, the more expensive are European exports abroad. That’s why business owners and politicians alike have discovered the exchange rate as a regulating device. In their view, a few downward turns will be enough to jump-start the European economy.

Simon Derrick, chief foreign currency strategist with U.S. lender BNY Mellon, holds a similar view. “I’m surprised that the ECB isn’t intervening directly in the foreign currency market, since everyone wants a weaker euro,” he said.

But it should really be up to the market to determine what constitutes suitable exchange rates. For years, the European Central Bank’s monetary policy was shaped by the maxim: “We don’t comment on exchange rates.”

Those days are gone now. The exchange rate has become a political issue, as evidenced by the fact that central bank chief Mario Draghi is commenting on the exchange rate at all.

“The fundamentals for a weaker exchange rate are today much better than they were two or three months ago,” Mr. Draghi said after the last meeting of the ECB governing council. This alone was a signal to euro speculators that the euro is heading downward.

Mr. Draghi’s words probably weren’t even needed. Investors have long recognized that the economies in Europe and the United States are developing in different ways. This has led them to invest outside the euro zone, which harms the common currency.

The euro will continue to lose ground against the dollar in the coming months, according to Union Investment, the investment fund owned by the association of German cooperative banks known as Volks- und Raiffeisenbanken.

It will become more attractive for investors to invest in American bonds, according to Frank Engels, head of fixed-income management at Union Investment. “And that also strengthens demand for the dollar,” he said.

The exchange rate has become a political issue, as evidenced by the fact that ECB chief Mario Draghi is commenting on the exchange rate at all.

The euro has headed in only one direction – down – since the exchange rate scraped at the $1.40 mark in early May. After that, the euro declined for seven months in a row, something that hasn’t happened in a decade. And the end is still a long way off. Many analysts have revised their predictions downward, and those predictions are currently averaging at a rate of $1.28 per euro by the end of 2015.

According to data from the U.S. Commodity Futures Trading Commissions, speculators are betting more strongly on a falling euro than they have in two years. Profits beckon when lawmakers set the course.

For analysts, the fact that Mr. Draghi mentioned the number of contracts on the futures exchange was a sign that he approved of the euro’s decline. Still, many economists warn against expecting too much from the declining euro. “It would be wrong to see the low exchange rate as a panacea,” says Stefan Schneider, head of macroeconomics research at Deutsche Bank.

Thanks to the weak currency, European companies expect to see competitive advantages in the short term – which could quickly be offset by rising inflation.

This is why Deutsche Bank warns against exploiting the exchange rate for political ends. “A few euro countries reflexively call for a weaker currency as soon as exports begin to falter. But for decades Germany demonstrated that you can also be successful with a strong currency.”

This article was translated by Christopher Sultan. The authors can be reached at: baecher@handelsblatt.com,  muenchrath@handelsblatt.com, narat@handelsblatt.com and slodczyk@handelsblatt.com

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