Euro’s rise hits inflation target

Euro’s rise hits inflation target

By Oliver Mangan.

Currency moves are a fresh headache for the ECB in its attempts to meet its 2% inflation target.

The euro’s sharp appreciation against the dollar, over the past year, makes it more difficult to get inflation in the eurozone back up to 2%, as it is putting downward pressure on import prices.

Underlying inflation in the eurozone is 1%. The ECB believes that this means there is a need for a continuing, accommodative monetary policy, despite the marked pick-up in economic activity in the eurozone.

At last week’s meeting of the ECB Governing Council, no changes were made to monetary policy. The key deposit rate was left at –0.4%, with the refi rate kept at 0%. Asset purchases under the ECB’s quantitative-easing (QE)

programme were cut from €60bn to €30bn per month at the start of the year. The programme is to run until at least September.

The ECB, once again, reaffirmed its commitment that, if necessary, the quantitative-easing (QE)

programme could be extended beyond this date and/or increased in size. Thus, the ECB continues to take a very cautious approach to withdrawing its monetary stimulus.

ECB president, Mario Draghi, said that currency strength could cause the ECB to think about its monetary strategy. He emphasised that the ECB expects to keep interest rates at their current, very low levels well past the end of the net-asset purchases. He said this was of “fundamental importance”.

Indeed, Mr Draghi said that he sees “very few chances, at all”, that interest rates will be raised this year.

Markets, though, are getting nervous and pushing eurozone bond yields upwards. Last week, the benchmark, 10-year German bond yield hit its highest level since 2015. The markets are looking at the very strong economic data coming out of the eurozone. They believe that the ECB will wind up net-asset purchases later this year and begin raising interest rates early next year. Markets expect that the ECB will have moved fully away from negative interest rates by the summer of 2019.

The ECB is in a difficult position, with eurozone economic growth picking up pace last year. This does not sit too well with the ECB’s negative interest rates and QE policies. Early insights into the performance of the economy, at the start of 2018, suggest a further pick-up in activity. The ECB will be slow to act, though, with inflation well below target.

Oliver Mangan is the chief economist with AIB.

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