HAPPY BIRTHDAY ECB!
publication date: Jun 12, 2008
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author/source: Drew Hillier (June July 2008)
If, as the popular saying goes, a week is a long time in politics, then – in the case of economics – a decade must be an eternity! Markets go up, markets go down, but in June, endless talk of credit crunches, global storm clouds and recessionary pressures was suspended, at least for a day or two, whilst the European Central Bank broke out the bubbly and bunting.
Confounding the Groucho Marx “anyone can grow old, all you have to do is live long enough” maxim, the ECB has done more than reach its tenth birthday simply by staying in existence. Having toughed the ups and downs, from infancy under Wim Duisenberg’s Presidency, to maturity with Jean-Claude Trichet at the helm since 2003, the past ten years been mightily short in comparison with the duration of the deepening of the European Union; an historic endeavour, rich in successes, accomplishments which in Trichet’s words, “…call for celebration, for reflection and also for continuous efforts as regards the future.”
HAPPY BIRTHDAY TO EU...
And celebrate they did! Although just a fraction of the many tens of millions of Eurosystem citizens were actually invited to the party, the ECB’s top officials certainly enjoyed one almighty knees-up! In a ceremony heavy on economic prescriptions and light on rhetoric, the institution responsible for the stability of the common European currency (introduced on January 1st, 1999) celebrated its coming into existence on June 1, 1998, in preparation for what became the biggest experiment in monetary economics since the world abandoned fixed exchange rates in 1973.
President Trichet, hosting luminaries including Chancellor Angela Merkel of Germany and the European Commission president, José Manuel Barroso, paid tribute to the euro as a highlight of the progress made in European integration since the process began 60 years ago, saying: "The single currency is the most advanced feature of European unity and in many respects its emblem," Trichet said. "We owe it to the lucidity of the founding fathers and to the determination of a series of visionary leaders", he said, referring further, and with more than a hint of General de Gaulle-ist common destiny sentiment, to the founding fathers of modern Europe, “…whom Trichet said, “we owe an immense debt of gratitude. Gratitude also to the leaders who maintained a steady hand during the 1990s in the run-up to the euro, in a very difficult environment. In the ECB and in the Eurosystem we are fully convinced that, with our fellow citizens, 320 million of them, we share a destiny in common – wir teilen dasselbe Schicksal – nous partageons un destin en commun.”
Angela Merkel, too, lauded the single currency now used across 15 countries, where, as she said: “Today, three-hundred-and-twenty-million people pay with the same currency. With that, they share something on a daily basis and ... that creates a European identity. The euro stands at the same time for a strong Europe whose voice has weight in the world."
A side-show marking the euro’s upcoming 10th anniversary has seen Greek sculptor, George Stamatopoulos, coming up with a new design to grace the new 2-euro. A primitive stick figure blending into the euro symbol will be distributed in January on some 90 million coins that will be issued by the 15 nations that use the euro.
With expansion in mind, ministers have just cleared new accession country Slovakia’s euro entry, which is due to happen on 1 January 2009. The decision that would see a 16th nation adopting the single currency, comes eight weeks after the European Commission and European Central Bank gave their blessings for the demise of the koruna. Slovakia still needs the approval of EU heads of state at a summit before the finance ministers fix the exchange rate in July, though concern remains that adopting the euro will lead to soaring inflation, as it did when neighbouring Slovenia adopted the single currency last year.
ECB: One Bank, One Currency, One Goal…
In his speech, delivered to a packed and enraptured audience at the 10th Anniversary ceremony in the suitably high renaissance splendour of Frankfurt’s Old Opera House (pictured below), President Trichet opened with remarks evoking the ECB’s and ESCB’s founding and primary mandate to preserve price stability and safeguard the credibility of Europe's single currency, a mandate and independence fulfilled – as Trichet reiterated – that with “the will of the democracies of Europe, were given by the people of Europe on a multi-national and multi-partisan basis. We are faithful to our mandate because we are faithful to the democratic will of the Member States.”
The ECB’s strict mandate to fight inflation - a stance that has not always made it popular with the continent's politicians, has been the case particularly over the past few months, with the euro at record highs against the dollar, a key reason for which being the ECB's refusal to cut interest rates (resolutely pegging them at 4 per cent since June 2007) while the US Federal Reserve has been slashing them to the bone.
Defending his notoriously hawkish stance, Trichet made clear the ECB won't be swayed by criticism from politicians, not least French President Nicolas Sarkozy. "We know that our fellow citizens are asking us to deliver price stability," he said. "We know also that price stability is a prerequisite for financial stability, a very important objective at the current juncture."
The ECB’s One Bank, One Currency, One Goal theme is taken up by Lena Manousarides, a professional trader and market analyst of FXGreece, pioneers in forex trading in Athens. As she says: “In the ten years which have passed since the formation of the ECB in 1998, its main goal has remained unchanged: to maintain price stability in all Euro-area nations and assist its steady economic growth. Team Trichet have managed to make the European economy one of the strongest in the world by raising the interest rates slowly but surely from 2% to today’s 4%. Last year’s favorable economic data allows for further increases with a view to making the Euro one of the strongest currencies in the world, and in the last four years, the EUR/USD has appreciated considerably from 1.20 to the recent all-time high of 1.60.”
In pointing up the successes, Manousarides acknowledges how the work of the ECB has been far from easy. “Their monetary policies have often come under fire from European officials who expressed concern over both the rise of the Euro and the interest rates.” However, as Manousarides comments further, “the ECB’s independence from political comment has made it easier to maintain price stability and low inflation, despite these comments. Perhaps most importantly of all, they have managed to avoid America and England’s financial crisis from dragging Europe into recession by to this day insisting that price stability is its main concern and inflation its worst enemy. The imminent monetary policy meetings will give us an idea of what’s next for the ECB, and will make a very interesting watch.”
Of a slightly more circumspect frame of mind when it come to ECB matters, Head of Calyon’s Global Foreign Exchange Research, Mitul Kotecha prefers to circumscribe his plaudits for the 10 year anniversary as being a cause for both celebration and commiseration. “The ECB can applaud itself in particular on the internationalisation of the euro and its success measured by its current strength”, says Kotecha, adding: “On the other hand, the rise in inflation to well above target highlights the lack of success in reining in inflation to the 2% target. At the inception of the euro its current success was almost unthinkable. The currency began its life in a precarious manner with confidence quickly sliding and the currency losing over 30% of its value against the US dollar to reach an all time low in October 2000. The drop in the euro came as a surprise, in particular to European officials who at the time of its birth believed the currency was fairly valued. They were quickly disappointed. Slowing growth together with structural concerns laid the path for close to a two-year slide in the euro to its all time low just above 0.82 against the dollar. The dramatic decline in the currency became a major concern not just for the ECB but for other central banks as it coincided with a strengthening dollar and ultimately led to coordinated intervention to strengthen the euro and weaken the dollar. This marked the turning point for the euro, which subsequently recovered, albeit shakily over the next few years to reach an all time high just above 1.60 against the dollar in April this year.”
Kotecha goes on to assert how “Over this period, confidence in the euro has increased dramatically and although it has not displaced the dollar as a reserve currency, its share of global foreign exchange reserves has grown as well as its use as an issuance currency. The Eurozone has registered a steady increase in capital inflows and in turn an improvement in its external position. Despite the initial concerns at the birth of the euro, structurally the euro has looked far more solid than the dollar given the burgeoning US current account deficit and the need for foreign capital inflows to fund this deficit. Cyclically, the slowing in the US economy, which has been exacerbated by the credit crisis, has provided a more recent rationale for the dollar to weaken and for the euro to strengthen. Looking ahead, there is little reason to expect confidence in the euro to worsen over the long term, but concerns about the outlook for growth and the strong reliance on the German economy suggests that the economy could be vulnerable in the months ahead. This in turn could be sufficient to put some downward pressure on the euro in line with our view that EUR/USD will fall to around 1.45 by year end.”
Barclays’ forex head David Woo, similarly argues that the recent rise of the euro will not threaten its long term success. Exchange rates are relative statements, and “the reality is that eurozone fundamentals have seldom compared so favourably with those of the US. Europe emerged from the global slowdown following the bursting of the information technology bubble with healthier public finances, faster productivity growth and less dependence on falling household saving rates to sustain its economic expansion,” he argued.
“Given that the Fed funds rate is now only 75bp above the ECB repo rate,” continues Woo, “any further narrowing of the interest rate differential will see further appreciation of the euro against the dollar. Aggressive Fed easing, as a result of a potential deepening of the US housing slowdown, will almost certainly push the euro-dollar exchange rate significantly higher, even above 1.50.”
EURO/DOLLAR
For the time being at least, and at the time of going to press, the euro continues to surge against the dollar, hitting an intra-day and seven-session high above $1.5750 after a weak U.S. jobs report caused stock markets to plunge. Pushing the greenback ever lower, the nervously-awaited indices showed unemployment swelling to a dismal 5.5 percent - its largest amount in 22 years, and described by Michael Woolfolk at Bank of New York Mellon as "…the first time in recent memory that the unemployment rate overshadowed the non-farm payroll number.”
Commenting on the report, Capital Forex’s Gavin Foster says: “Yet again the birth/death adjustment gave a surprisingly low reading in the overall non farm numbers. The reaction was dramatic as the US Dollar faced considerable pressure and fell against all of the majors. We believe that the Euro is now indicating that a revisit of the 1.60 level could be soon.”
Foster also pointed to the other major fall-out which occurred in the equity markets, where the Dow placed its 4th largest decline losing nearly 400 points as oil surged to $139. “Normally”, said Foster, “this would have assisted a weakening in the carry trade, but there was still support being demonstrated and we feel that the real weakness may be an issue for later next week.”
Earlier in June, Federal Reserve Chairman Ben S. Bernanke threw the weight of the central bank behind Treasury Secretary Henry Paulson's efforts to strengthen the dollar after its 10 percent drop over the past year. Bernanke said in a speech on June 6th the Fed is ``attentive'' to the currency and will guard against a jump in inflation expectations. Paulson a day before reiterated that he ``very strongly'' favours a ``strong'' dollar.
The Fed chief's signal that he's done for now with lowering interest rates may help stabilize the dollar after 3.25 percentage points of rate cuts since September reduced returns on U.S. investments and demand for the currency. Paulson began strengthening the U.S. stance in November by stating the dollar would reflect solid long-term economic fundamentals, a shift in rhetoric which former Fed insider, Stephen Jen, now chief currency economist at Morgan Stanley in London, said “…is one more reason to believe that the dollar has bottomed.''
Commenting on American GDP first quarter growth index of 0.6 per cent, Colin Asher, Senior Economist with Nomura International, says that “...equity markets have recovered recently but still down compared to the peak and also the house price - house prices continue to decline and the housing market continues to get worse and I'm not particularly optimistic that we'll see much pick-up in growth in the second half of the year.”
“If we had another big dollar leg down, I think it would raise the possibility of intervention,'' said Jens Nordvig, a Goldman Sachs Group Inc. currency strategist in New York. The ``more immediate implication'' of Bernanke's speech is that ``the threshold for Fed easing is higher than might otherwise be the case'' should the economy weaken later in the year, he said.
Lena Manousarides of FXGreece sees the EUR/USD as well worth observing, “…as this month’s positive tone could lead to a dollar comeback”, she says, adding: “Unwelcome dollar weakness comments from Bernanke are still fresh in trader’s minds, putting dollar bulls back in the game, and as long as the pair continues trading below 1.5630, it could approach the recent lows of 1.5280.”
As to how the news of dollar losses impacted on cable, Kathy Lien – Chief Currency Strategist with FXCM – believes that the rocketing British pound has very little to do with UK fundamentals, not least taking into account the economic indicators, including, as Lien points out, “…the continued decline in home values, stalling industrial output growth and jobless figures. However, there’s something to be said for building price pressures in the UK economy, as it is the main reason why the BoE did not cut rates just recently, the release of the producer price index (PPI) is likely to highlight this. Indeed, input and output prices are likely to rocket higher at the factory gate, which will underpin the BoE’s concerns about upside inflation risks and could lead the British pound continuing on a strong note.”
The Bank of England’s decision to leave rates unchanged at 5% on June 5th is, opines Director at Currencies Direct, Mark O’Sullivan, “expected to remain on hold for some time as the country faces the combined effects of slowing economic growth and soaring inflation. However, while most economists agree that near term inflation expectations will probably keep the BoE from cutting rates in the near term, expectations of a further deterioration in economic conditions is likely to bring rate cuts back on the table by year-end. Time will tell.”
THE PARTY’S OVER
Certainly, European officials have expressed concern at the euro's climb versus the dollar. European Central Bank board member Christian Noyer said ``one can hope'' the gap between the euro and the dollar may narrow. ``Markets often push currencies beyond the ranges in which we'd like to see them.” Noyer then when on to assert how Europe was facing a "huge shock" as contagion spread from the US sub-prime crisis. "We should see an inflation plateau which should nevertheless drop off rapidly," he said, "provided of course we avoid a spiral of prices and wages that would squeeze companies' margins."
In summing up his ECB tenth birthday address, Jean-Claude Trichet said how this was no time for complacency, rather that “the continuous efforts, because the challenges lying ahead for Monetary Union, will be numerous and demanding. As one of the major central banks in the industrialised world, we, like the others, have three challenges to cope with in our monetary policy-making: rapid technological progress, globalisation in all its dimensions, including the transformation of global finance, and population ageing.”
And with that, no sooner had the celebratory jelly and ice cream been sponged off the Old Opera House’s parquet, than normal service resumed: the next day’s headlines read: European Notes Post Weekly Decline as ECB Signals Rise in Rates. The news came in response to remarks made by Trichet on German television, which – though hawkish as ever – in suggesting that the ECB was in state of heightened alertness nonetheless surprised the market. ``We're seeing price increases on a broad front and monetary policy must counter that,'' he said, adding: “Markets should prepare for this.'' The ECB inflation-curbing interest rate rising sentiment in turn spooked US economic policymakers. Concerned Washington officials worry that if the ECB tightens monetary policy next month, it would undermine efforts on both sides of the Atlantic to prevent the dollar weakening even further against the euro. "The weak dollar story has morphed into a strong euro story by virtue of the ECB's signaling a rate hike next month," said Marc Chandler, senior currency strategist at Brown Brothers Harriman in a research note to clients. "Few can keep up with the euro."
In response, the three-month Euribor jumped by the most in more than seven years to 4.97 percent. Portugal become the first European government to protest against the President’s interest rates talk, saying a hike would hurt its fragile economy. "This scenario of higher interest rates will raise problems for many Portuguese families who are in debt," Portuguese Finance Minister Fernando Teixeira dos Santos told reporters after a meeting in Paris. Simon Denham, MD of Capital Spreads, summed matters up, saying that the ECB “...has set the cat among the pigeons, being the first of the major blocs to indicate that, far from wishing to protect growth with rate cuts, they are more inclined to fight inflation.”
As for market response, John Hardy, Saxo Bank’s FX Market Strategist said “…we rated the Trichet press conference scenario in which he came out preparing the market for rate hikes as the "biggest surprise" and rated it as a low odds proposition. It shows what happens when the surprise scenario comes to pass. The odd thing in our view with all of the tough talk on inflation from the Fed and the ECB is that we seem to have an ugly Round 2 of the credit crisis brewing in the background - have the Fed and ECB lost the plot? Going long risk aversion trades may be the best bet soon.”
As with all good parties, having attended the ECB shindig, eurozone policy-makers could now be suffering from a permanent hangover. The euro, certainly, looks like facing one of its most significant challenges in ten years.
C'est la Vie, as they say in France…
