As euro strengthens, debate grows about setting a 'target' value

Finance ministers of the 17-member eurozone failed to find a united front Monday to address concerns over the risks a rising euro poses to the fledging economic recovery, as fears of a global currency war loom.

France, for its part, wants an exchange rate target that the European Central Bank would have to defend. Germany and other northern European countries, however, have played down the idea, and most eurozone countries reject ECB intervention precisely to prevent other global economies from retaliating.

The current chatter over the euro's strength comes in response to rising global concern over artificial currency manipulation, something many accuse Japan and the US of doing. French Finance Minister Pierre Moscovici blamed the euro’s strength on “more aggressive practices by some of our partners.”

At about 1.34 per dollar, the euro remains strong, around 13 percent higher than last July, but still far from the 2011 high of nearly 1.50 per dollar. While its strength may hurt the overall European economic recovery, it particularly affects struggling southern European nations who lack their northern neighbors' dominance in specialized products that are less exposed to competitors. 

ECB President Mario Draghi, last week, effectively sided with Germany’s reluctance to accept France's proposed market intervention, but also suggested the ECB stands ready to react in case other countries manipulate exchange rates.

“The exchange rate is not a policy target. We certainly want to see whether the appreciation is sustained and will alter our risk assessment as far as price stability is concerned,” Mr. Draghi said. The ECB will “monitor” the currency’s fluctuations “and their potential impact on the stance of monetary policy, which will remain accommodative.”

The ECB could lower interest rates, for example. A stronger euro means inflation decreases because imports cheapen. By lowering lending rates, liquidity increases and the euro weakens.

Hands tied

Still, the ECB is hamstrung, as it does not have the power to print more money or to buy government bonds to stimulate eurozone economies, as other central banks do. The US and Japanese monetary easing –which injects billions of cash into their economies – devalues their currencies and makes their exports cheaper.

Furthermore, the recent strength of the euro is a consequence of its own success. European private banks paid the ECB back, ahead of schedule, 140 billion euros  they were loaned last year to recapitalize amid the crisis. As a result, the ECB’s balance sheet improved, strengthening the currency. 

“This reflects the improvement in financial market confidence. The appreciation is, in a sense, a sign of return of confidence in the euro,” Draghi said.

The opposite is happening in the US and Japan where the governments are pouring in billions to spur economic growth, hurting the balance sheet, and weakening their currencies.

Countries like Spain and Italy are especially exposed. Government policies have helped to strengthen their export markets, even if not domestic consumption, in one of the few bits of welcome news in an otherwise gloomy economy. A stronger euro could derail prospects of their economic recovery, and that of the EU.  

 Currency wars

Finance ministers of the world’s 20 biggest economies, the G-20, will meet Friday as rhetoric over a currency war heats up. In addition to European criticism of Japan, countries like Brazil criticized recent calls to manipulate currencies.

The G-7, which includes France, Germany, the US, and Japan, is expected to uphold market-determined exchange rates then, and Japan will likely have to defend its economic policies, in an effort to prevent a “currency war.”

What remains uncertain is if the world’s biggest economies can avert resorting to unilateral monetary policies, including in Europe, that reverberate globally and threaten to trigger retaliation.