Euro Blues

Talking Down The Currency, ECB President Draghi Plays a Dangerous Game

Draghi Yellen-Reuters
Can words speak louder than action? ECB President Mario Draghi, pushing for a weaker euro, hopes to get help from U.S. Federal Reserve Chair Janet Yellen.
  • Why it matters

    Why it matters

    The ECB President Draghi holds tremendous power to direct markets. If he gets the tone right, his calls for a weaker euro could help drive up inflation and revive the euro zone’s sputtering economy.

  • Facts


    • The euro is currently trading at $1.34 against the U.S. dollar, down from $1.40 at the start of the year.
    • ECB President Mario Draghi wants to ensure that the single currency does not appreciate, crimping exports and dampening inflation.
    • Growth in the euro zone stagnated in the second quarter of this year.
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Mario Draghi is walking a very fine line in talking down his own currency of late. Should the European Central Bank (ECB) president succeed, he could help boost the euro zone’s fragile economy. If he goes a step too far, he risks sending the euro currency into a downward spiral just as the region is recovering from a major debt crisis.

Such is the power of a central banker – Mr Draghi’s words carry tremendous weight with international investors. Should he find the right tone, he can influence market movements in exactly the direction he wants without taking a single action. Economists call this “verbal intervention.”

Mr. Draghi has been singing a new tune for the last few months – call it the “euro blues”. The shift in tone has been carefully calibrated, but Mr. Draghi reached one of his highest notes yet last week, telling reporters that “the fundamentals for a weaker exchange rate are today much better than they were two or three months ago.”

A central banker talking down his own currency? This used to be a no-go for the ECB. Back at his monthly press conference in March, Mr. Draghi still insisted the value of the euro was “not a policy target,” though “very important for growth and price stability.” Last week, the words “not a policy target” were left out of his comments altogether.

For Commerzbank analyst Ulrich Leuchtmann, this was a clear signal. He noted that Mr. Draghi also listed a series of reasons for why the euro has weakened, making clear that “a weaker euro has at the very least become an interim goal of the ECB’s monetary policy.”

“The dangers of currency wars are definitely there.”

Peter Bofinger, Economic advisor to German Chancellor Angela Merkel

These verbal interventions have had some effect. The euro, which was trading at $1.40 against the dollar at the start of this year, has since fallen back to $1.34, marking a 5 percent swing that is significant in foreign currency exchange terms.

Currency Wars

Some politicians are no doubt happy about this development. Policymakers in France have long been actively calling for more measures to weaken the euro, including Finance Minister Michel Sapin and even Airbus chief executive Fabrice Berger. Some economists have also backed Mr. Draghi’s currency interventions to aid the 18-nation euro zone, which is fighting desperately to avoid deflation.

“Verbal interventions are the most pain-free and effective tool that exists to prevent the inflation rate from falling further,” said Peter Bofinger, an economic advisor to Chancellor Angela Merkel. Such measures are “urgently required” at the moment, he said.

Yet such interventions also carry risks. In a world that is still reeling from the financial crisis and where many countries are struggling to boost their growth rates, the euro zone is not the only region that would like to see the value of its currency decline.

“The dangers of currency wars are definitely there,” Mr. Bofinger said.

Indeed, European policymakers have made a point in the past of criticizing other countries for such interventions. China has long been accused of artificially holding down the value of its currency.

Draghi Schäuble-dpa
German Finance Minister Wolfgang Schäuble thinks the market should dictate the value of the euro, not politicians. Source: DPA


German policymakers have long been more cautious about talking down the euro. “I don’t think much of political discussions over the exchange rate,” Germany’s finance minister, Wolfgang Schäuble, told Handelsblatt in July. “This is determined by the market.”

Desperate Times Call for Desperate Measures

The ECB’s line in normal times has been the same – markets should determine the value of the euro and not central bankers. But these are not normal times. The central bank in June brought interest rates to a record low of 0.15 percent and for the first time in history began charging banks for depositing their reserves with the ECB.

And yet despite all these measures, growth in the 18-nation euro zone currency bloc remains desperately weak. Figures released Thursday showed GDP growth stagnated in the second quarter of this year, another bad omen after the economy had grown 0.2 percent in the first three months of the year.

The risks to growth are increasing, the ECB warned in its monthly report on Thursday. Geopolitical risks stemming from the Ukraine crisis and conflicts in the Middle East, as well as a slowdown in emerging economies, “may have the potential to affect economic conditions negatively,” the ECB said.

“I don’t think much of political discussions over the exchange rate. ”

Wolfgang Schäuble, Germany’s Finance Minister

The growth concerns mark a second challenge for the ECB, which is already struggling with its top concern – inflation. Consumer prices in the euro zone grew at a paltry 0.4 percent in July. Commerzbank expects it could hit a trough of 0.3 percent in August as a drop in energy prices continues to weigh on inflation. That is dangerously close to the deflation that the central bank fears most, and well below the central bank’s goal of keeping consumer price increases at “below, but close to, 2 percent.”

A weakened euro would kill two birds with one stone. It would help companies by making Europe’s goods cheaper abroad, increasing exports and thereby growth. It would also make foreign goods more expensive, raising inflation in the process as consumers have to shell out more money to buy their favorite American or Asian products.

Help From the United States

Analysts expect the euro will continue to fall further in the coming months. This is not just due to Mr. Draghi’s magic words but to those of another central banker – U.S. Federal Reserve Chair Janet Yellen.

Ms. Yellen has many foreign exchange market experts once again betting on the dollar. The U.S. economy has recovered faster than the euro zone from the 2008-2009 financial crisis. That means the Federal Reserve has begun drawing down on the it’s own series of extraordinary measures taken to rescue the U.S. economy.

The United States could soon see the Fed begin to raise interest rates, while the ECB can be expected to keep interest rates low for a while yet. The United States economy is growing, while the euro zone is stagnating.

This has many market watchers predicting the euro-dollar exchange rate could fall to $1.30 by the spring of 2015. Mr. Draghi could be singing the euro blues for a while yet.

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