Strong euro clouds interest rate outlook

7th January 2004, Comments 0 comments

7 January 2004 , FRANKFURT - A soaring euro raises the prospect that the European Central Bank's 18-member rate-setting council may be forced to cut borrowing costs in coming months to curb the currency's rapid advance, but most analysts say not at this Thursday's meeting. Most analysts believe the ECB sees the signs of an economic recovery in the 12-member eurozone as helping to counterbalance concerns about the surging common currency. As a result, financial markets expect the bank's governing council wi

7 January 2004

FRANKFURT - A soaring euro raises the prospect that the European Central Bank's 18-member rate-setting council may be forced to cut borrowing costs in coming months to curb the currency's rapid advance, but most analysts say not at this Thursday's meeting.

Most analysts believe the ECB sees the signs of an economic recovery in the 12-member eurozone as helping to counterbalance concerns about the surging common currency.

As a result, financial markets expect the bank's governing council will this week keep its benchmark refinancing rate on hold at its historic low of 2 percent.

But going forward the picture is becoming less clear with the euro having at one point breezed past the USD1.27 dollars marker Tuesday as it launched its drive towards the psychologically important USD1.30.

The euro climbed by more than 20 percent against the dollar last year with the common currency rising at a much faster pace than predicted by even some of the more bullish forecasts for the currency.

Indeed, the euro now appears to heading towards what economists are calling the "pain threshold" - when the stronger currency starts to hit the eurozone's export machine, which is a key pillar of growth.

"The scenario for economic recovery has not changed," said Rainer Guntermann, European economist with the investment house Dresdner Kleinwort Wasserstein. "The exchange rate is now the focus."

As a consequence, the financial markets will be keenly following the comments by ECB chief Jean-Claude Trichet at his regular press briefing following the bank's meeting Thursday for indications as to how the governing council is sizing up the euro's dramatic climb.

In particular, this includes any signs that the ECB has become somewhat worried about the very dramatic rise in the currency, which jumped by about six per cent against the dollar in December alone.

To be sure, while ECB officials have tended to wave off expressions of concerns about the strong euro, the euro's sharp appreciation has hardly been along the lines of the orderly movement in exchange rates that central bankers prefer.

For the time being, however, the ECB will probably be content to allow the strong euro to help bear down on inflationary pressures with consumer prices dipping to 2.1 percent in December compared to 2.2 percent in November.

But market sentiment about Europe's interest rate outlook appears to be changing.

Towards the end of last year the consensus among analysts was that eurozone rates would likely be on hold until the middle of 2004 when the ECB responded to evidence that economic growth in the currency bloc was gaining momentum by tightening monetary policy.

Most economic forecasters still believe that the ECB's next monetary move will be to hike rates as data confirms the bank's own forecasts that Europe is on track to a modest economic upturn.

But the timing of the rate hike is becoming increasingly doubtful with the euro's relentless rise now appearing to have pushed any monetary tightening back until later in the year if not into 2005.

Moreover, market expectations that the euro might now make its way towards USD1.35 appears to have put interest rate cuts back on Europe's monetary agenda.

This week Germany's influential DIW economic research institute identified the trading zone between USD1.30 and USD1.35 as the point at which the ECB will be forced to deliver another rate cuts so as to help ease the tight monetary conditions resulting from the stronger euro.

Already analysts say that the spiralling euro has meant that financial markets are starting to price out a rate hike during the course of 2004.

But having last cut rates by a hefty 50 basis points in June, analysts believe that before the ECB does move again to trim borrowing costs it is likely to try to at least verbally intervene in the market in an attempt to stem the dollar's slide against the euro.

 

DPA
Subject: German news

 

 

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