Why The ECB Should Refrain From Commenting The Exchange Rate

Something which took many currency traders by surprise this summer was the ECB delivering one of its rarest verbal interventions, just at the point when the EURUSD crossed the 1.20 rate. 

There is an unwritten agreement, a gentlemen’s agreement, if you may, between the G20 countries, not to comment on exchange rates. For the ECB to try to talk down the Euro just a couple of weeks ahead of its regular meeting was not only new, but also strange.

The IMF Still Finds the Euro Undervalued

By agreeing to refrain from competitive devaluation, the G20 countries planned to avoid boosting exports and avoid current account developments at the expense of other nations. Yet, talking down your currency signals exactly the opposite.

Yes, the EURUSD exchange rate, the one Phillip Lane mentioned, did rise dramatically and in a noticeably short term. It moved from 1.06 to 1.20 in less than three months, putting pressure on an already weak inflation.

However the Euro in nominal terms barely rose more than 4% this year. This is, by far, nothing alarming – just the opposite. If we look at the current account surplus in the Euro area, driven higher by Germany and the Netherlands, we actually see a lower Euro than the current account would suggest. This is one of the reasons why the International Monetary Fund (IMF) perceives the Euro as undervalued when compared to its peers.

Perhaps the Europeans are retaliating to what is happening in the United States in the last four years. Before Trump’s presidency, the White House would never comment on the exchange rate. In fact, the mantra was that a stronger dollar policy is favored.

That changed dramatically in the last years. The Trump administration tried desperately to push the dollar lower, often with verbal intervention from the President himself.

As such, the ECB may have viewed it as an unfair playing field. If the rules are broken, then let them be broken for all parties. But if history tells us anything, such an approach is neither wise nor welcomed.

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