Do not expect the eurozone to wage currency war

By:
Peter Garnham
Published on:

Currency wars, traditionally the preserve of emerging market policymakers, have gone mainstream, but the eurozone is unlikely to enter the fray.

The start of 2013 has been notable for the number of officials from around the globe that have decided to air their views on the strength of their currencies, or indeed the weakness of those of other countries.

Among developed nations, Japan has been the most aggressive in recent weeks, continually underlining its desire for a weaker yen to boost growth and fight deflation.

Perhaps the most surprising interjection, however, were comments from Jean-Claude Juncker, outgoing chairman of the Eurogroup of finance ministers, who on Tuesday said the euro was “dangerously high”.

The comments took the wind out of the sails of the euro, which has been rallying steadily since the European Central Bank’s (ECB) meeting last week, when Mario Draghi, the central bank’s president, in effect called the end of the eurozone’s debt crisis.

So, do Juncker’s comments on euro strength serve as a warning to the market and play to concerns expressed recently by Alexei Ulyukayev, first deputy chairman of Russia’s central bank, that the eurozone will follow Japan’s lead?

That prospect seems remote.

Certainly, the eurozone economy could do with a weak currency, but in the current environment so could every nation on Earth.

The fact is, however, that the euro is simply not dangerously high. Indeed, that was a sentiment expressed by Draghi only last week, who emitted little concern for the euro’s strength, saying its real effective exchange rate was close to its long-term average.

The euro has rallied strongly against the dollar and the yen recently, but in trade-weighted terms it is still down 11% from its peak of October 2009, and is just 6% since the inception of EMU in 1999. That hardly looks dangerously high.

Perhaps more importantly, as pointed out by Steve Barrow, head of FX strategy at Standard Bank, eurozone policymakers, and especially those at the ECB, do not see the euro as something that should be manipulated for trade and economic gain.

“Policymakers see the euro as the embodiment of the EMU project,” says Barrow. “Hence, they will intervene to defend it if the currency’s slide calls into question the longevity and viability of EMU – as the ECB did in 2000.

“But it will be far more reticent to act to stop euro strength, as this strength is seen as a reflection of the attractiveness and durability of EMU.”

Indeed, eurozone policymakers are likely to feel good about the fact the euro has held up well, despite the region’s sovereign debt crisis, and are unlikely to want to jeopardize that.

It is even arguable that a slide in the euro at the height of the crisis might well have blown the whole EMU project apart.

Barrow maintains that policymakers at the ECB worked overtime to solve the eurozone’s debt crisis while not undermining the euro – a feat they appear to have pulled off for now.

Stability in the euro is, in other words, a hard fought necessity at the heart of the EMU project. Do not expect eurozone policymakers to try to talk their currency down, even if weakness in the single currency has the potential to alleviate some of the strains in the region’s economy.