Tuesday February 5, 2013

All eyes on eurozone central banks

ECB and BoE firmly on hold of their stance but unease stirs over euro strength

LONDON: Central banking is in a state of flux as policymakers from Tokyo to Washington ditch prevailing orthodoxies to try to grab a bigger share of a slow-growing global economic pie.

That's why the focus this week will be on what European Central Bank (ECB) governor Mario Draghi has to say about the strength of the euro and what Canadian central bank chief Mark Carney might have in mind when he succeeds Mervyn King at the Bank of England (BoE) in July.

Draghi holds a news conference on Thursday after an ECB policy-setting meeting. On the same day, with delicious timing, Carney will be wrapping up testimony to British lawmakers just as the BoE announces the results of its own policy meeting.

The unanimous verdict of economists polled by Reuters is that neither bank will change its stance. The environment, however, is shifting, presenting both with unwanted challenges.

The ECB must keep a close eye on the euro, which has risen to a 14-month peak against the US dollar and a 30-month high against the yen, reflecting the Federal Reserve's promise to keep buying bonds until US unemployment falls much farther and the Bank of Japan's plan for a much looser monetary policy.

Exchange rates have much less of an impact on trade volumes than the state of external demand.

But, with global growth languishing, the relative performance of eurozone exporters would take a hit, said Daniel McCormack, a strategist at Macquarie in London.

“The euro could well be starting to cause a bit of pain already. It's moved up significantly, and in the context of what Japan's doing and the Fed's desire to get the dollar down or keep it low, it will have some impact,” he said.

France has already complained about the euro's climb and Germany has blamed Japan for encouraging a weaker yen.

But Goldman Sachs said an ECB rate cut in response to a rising euro was still some way off, not least because the currency's vigour was largely due to improving economic and financial news from the eurozone.

The bank's economists did acknowledge, however, that the risks to its forecast that rates will stay on hold in 2013 were skewed to the downside.

“While global growth is picking up and demand growing, concerns about appreciation may be muted. But a strengthening euro in a stagnant global economy is likely to prompt questions about where the pain threshold' of German exporters to the level of the euro exchange rate lies,” they said in a report.

Like the US dollar, sterling has also fallen to a 14-month low against the euro.

British policymakers view a weaker pound as part of the solution to reviving the economy, which stagnated in 2012, and Goldman is among those who expect continued depreciation given the prospect of a more innovative and expansionary monetary policy under Carney.

McCormack reckons the shortfall in Britain's potential output that has opened up due to the recession is so great that the BoE might not need to contemplate tightening until 2018 a full decade after the financial crisis climaxed. - Reuters

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