Exchange rate worries ECB

5 February 2004

FRANKFURT – The European Central Bank left Thursday its benchmark lending rate on hold at an historic low of two per cent with ECB bank chief Jean-Claude Trichet expressing concern about exchange rate volatility ahead of a key Group of Seven meeting in Florida.

Speaking at a press conference following a meeting of the bank’s 18-head rate-setting council, Trichet said the ECB believed that recovery in the 12-member eurozone would proceed in line with its expectations.

But with the euro again advancing on forex markets Trichet said that the governing council wanted to particularly to stress exchange rate stability, adding that the bank remained concerned about excessive exchange rate moves.

Since the ECB’s last meeting a month ago, Trichet has spearheaded a campaign by bank officials to talk down the euro, which has jumped by about 20 percent over the last year.

But in the wake of Trichet’s comments to reporters Thursday the euro shot past USD 1.26 with some analysts predicting that the common currency could hit USD 1.30 in the coming months and consequently adding to concerns in the eurozone about the impact of the strong common currency on export growth.

The euro was trading up at USD 1.2551 as the members of the ECB’s governing council gathered for Thursday’s meeting with the five-year old currency having hit an all-time high of USD 1.29 last month.

The ECB last cut rates in June last year, when it trimmed borrowing costs by a hefty 50 basis points.

In his comments to reporters Thursday, Trichet also rejected moves among eurozone member states to reform the so-called stability pact, which sets out strict fiscal targets aimed at helping to shore up market confidence in the common currency.

While most analysts believe that the ECB will keep rates steady possibly until well into the new year when it could launch moves to tighten monetary policy, many analysts have not ruled out the prospects of the ECB being forced to deliver another rate cut in the coming months if as expected the euro again charges ahead against the dollar.

Thursday’s ECB meeting also came against the backdrop of the build-up to a key meeting of the Group of Seven in Florida starting Friday with Trichet’s comment underscoring hopes in Europe that the meeting of G-7 finance ministers and bank governors might make moves to bolster the dollar.

But Trichet would not be drawn on the what might eventuate at the G-7 meeting, which he is also scheduled to attend.

“It is not my tradition… to announce in advance anything as regards the G-7,” he said. “We will have the usual and customary press encounter to explain the communiqué.”

The ECB meeting also coincided with a decision by the Bank of England to raise borrowing costs by 25 basis points on the back of concerns that stronger economic growth could result in renewed inflationary pressures. This is the second time in four months that the Bank of England has increased rates.

Adding to optimism that the upswing in the eurozone is gaining strength, data released Thursday showed key factory orders in the currency bloc’s biggest economy, Germany, rising by a stronger-than-expected 1.2 percent in December.

The increase was a result of a surge foreign orders which helps to support the ECB’s argument that the pickup in the global economy is likely to offset any negative impact from rise in the common currency.

Moreover, Trichet went on to say Thursday that the euro’s steep rise will help to contain inflation with consumer prices expected to dip below two per cent during the course of the year.

But despite the somewhat upbeat assessment of the eurozone’s economic prospects made by bank officials, including Trichet, concern is growing in Europe that the strong euro is already starting to dampen exports before signs that private consumption in the currency bloc is taking off.