Currency Controls

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Lower Euro Helping in Short Run, But Inflation Awaits

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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.

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