Frankfurt (Germany) (AFP) – A rising euro and falling inflation will present fresh challenges for the European Central Bank at its meeting Thursday, potentially reviving debate about if and when policymakers should start cutting interest rates. There is little doubt that the central bank for the 21-nation single-currency area will keep its benchmark rate on hold at two percent for its fifth straight meeting. However, a marked strengthening of the euro last week, followed by news that eurozone inflation eased to 1.7 percent in January — below the ECB’s two-percent target — will invite questions about whether rate cuts are on the horizon.
A stronger currency makes imports cheaper, which could drive inflation down even further, potentially leading consumers to delay purchases, with negative ripple effects across the economy. Yet, a strong euro can also weigh on the eurozone’s crucial exporters, particularly Germany, as it makes the cost of companies’ goods pricier overseas. This could thus hit the eurozone economy at a time when growth is starting to get back on track, potentially undermining efforts to close the gap with China and the United States.
ECB President Christine Lagarde has at recent meetings emphasised that the central bank is in a “good place,” seen as indicating that policymakers are happy with the current level of rates. However, for Carsten Brzeski, an economist at ING, recent market developments “have started to make the ECB’s ‘good place’ a little less comfortable.” He noted, “The weakening of the US dollar and hence the strengthening of the euro have led to some unease at the bank.”
The euro has been gaining ground for some time, particularly due to worries about US President Donald Trump’s volatile policies, from levelling tariffs against trading partners to threatening to seize Greenland. It extended gains sharply last week as investors sold off the dollar, briefly hitting a four-and-a-half-year high above $1.20.
While emphasising that recent euro gains were “modest,” Austrian central bank governor Martin Kocher warned last week that the ECB might have to consider rate cuts if there were further increases. Lowering borrowing costs tends to support inflation while weakening currencies. “If the euro appreciates further and further, at some stage this might create of course a certain necessity to react in terms of monetary policy,” Kocher, who sits on the ECB’s rate-setting Governing Council, told The Financial Times.
The ECB does not target any particular exchange rate, but officials do monitor currency movements as they could impact inflation. A stronger euro is not all bad news — it boosts household spending power at home and on holidays overseas. The rise of the single currency also points to the growing appeal of Europe at a time of investor worries about the United States and Trump’s unorthodox stewardship of the world’s top economy.
At a press conference after the rate decision Thursday, Lagarde is expected, as usual, to stay tight-lipped on the future direction of rates. When asked about the euro, the ECB chief will likely opt for phrasing along the lines of “we are…monitoring developments,” Marco Wagner, an economist at Commerzbank, told AFP. She will avoid “indicating a clear direction for monetary policy if the euro reaches a certain exchange rate,” preferring instead to “remain neutral,” he added. However, given the slowdown in inflation, analysts at Capital Economics said they had now “pencilled in rate cuts towards the end of the year.”
© 2024 AFP
