From Stockholm to Prague, Copenhagen and Zurich, officials in European nations circling the currency bloc are waiting for the European Central Bank (ECB) President Mario Draghi to say next month whether he would expand stimulus.
Only then would it be clear whether they would need to retaliate with more asset purchases, rate cuts and currency interventions of their own to dig in against imported disinflation.
The ECB’s bonanza of cheap cash is depressing financial returns in the euro area and driving investment flows into neighboring nations, pushing up their currencies and defeating their efforts to hit their own inflation targets.
Looser monetary policy is in the cards even in nations where economic growth is strong and asset markets are overheating.
“These countries don’t want to be the losers in the currency war they think the ECB is participating in,” said Marchel Alexandrovich, senior European economist at Jefferies International Ltd in London. “It’s a zero-sum game. If you’re trying to devalue, then there’s always someone on the other side of that trade.”
After Draghi announced a 1.1 trillion euro (US$1.2 trillion) bond-buying program on Jan. 22, holdings by euro area residents of debt and equity in the nine EU nations outside the currency bloc soared to fresh records, ECB data show. Total portfolio investments rose more than 9 percent in the first quarter to 2.05 trillion euros.
The movement of cash had the effect, not unwelcome at the Frankfurt-based ECB, of helping push the euro down against currencies including the Swedish krona, Poland’s zloty, the Czech koruna and the Hungarian forint. Most dramatically, the Swiss National Bank on Jan. 15 pre-empted the ECB’s decision by abandoning its cap on the franc.
While ECB officials have repeatedly said they do not target the exchange rate, they have acknowledged that a weaker euro helps revive the economy and inflation by boosting exports and pushing up import prices. The single currency has dropped almost 7 percent on a trade-weighted basis this year and since the ECB started considering new stimulus has dropped to the weakest in three months.
The flipside is that nations seeing their currency strengthen face downward pressure on inflation rates already suppressed by falling energy costs. Swedish inflation is at 0.1 percent compared with a target of 2 percent. Denmark is at 0.3 percent and the Czech Republic at 0.2 percent. Consumer prices are declining in Switzerland, Poland and Hungary.
With euro-area prices also stagnating and the ECB considering whether more stimulus is needed, nations that have eased policy this year face having to do so again, even if unwarranted by domestic conditions.
Swiss real-estate prices remain risky, according to a measure by UBS Group AG, yet Swiss National Bank President Thomas Jordan has said the deposit rate could fall further from the current minus-0.75 percent. The central bank is to hold its quarterly policy review on Dec. 10, exactly one week after the ECB’s next meeting.
Swedish property prices have risen almost 50 percent since 2009 and GDP is growing twice as fast as the euro area, yet looser policy might be coming.
Riksbank Deputy Governor Per Jansson said last week that the bank is moving closer to intervening in the currency market.
“The more the ECB does in terms of quantitative easing, the more the Riksbank needs to do in order to avoid the Swedish krona becoming too strong,” said Par Magnusson, an economist at Swedbank AB in Stockholm.
In Denmark, unemployment is below 4 percent and the price of owner-occupied apartments rose 10 percent in the past year — yet action might be needed if the krone’s peg to the euro is to be maintained.
Moreover, figures published yesterday showed inflation slowed last month and Arne Lohmann Rasmussen, head of fixed-income research at Danske Bank A/S in Copenhagen, said conventional policy might have run out room.
“The deposit rate is probably at the effective lower bound at minus-0.75 percent,” he said. “If the Danish central bank has to respond to any new ECB actions that might trigger a stronger Danish krone, they’ll probably have to step up intervention again.”
Czech central bankers are having to push back the date on which they can give up their unpopular currency cap.
The Czech National Bank is struggling to normalize monetary policy even though it forecasts this year’s GDP would expand by 4.7 percent.
ECB officials can do little more than shrug when confronted with the distortions they are causing.
“We are mindful of the impact of our decisions on the rest of the world and in particular on neighboring economies,” ECB executive board member Benoit Coeure said on Nov. 4. “But our mandate is limited to the euro area.”
The ECB is not immune to policy overspill. Its decision next month might be influenced by the likelihood of the US Federal Reserve raising its own borrowing costs after seven years of near-zero rates. In that event, the best-case outcome for Draghi’s neighbors would be a diversion of global financial flows toward the US, and a stay of action in Frankfurt.
In the meantime, one nation has avoided contorting its policy framework to respond to euro-area pressure. Its approach: Ignore the inflation target.
Rather than expand its balance sheet in a vain attempt to stoke prices, the National Bank of Poland has reinterpreted its inflation goal and tolerated the longest bout of deflation since the communist era.
Marek Belka, the NBP’s governor and a former IMF official, has deferred a decision on cutting rates until next year, citing a healthy economy showing no signs of suffering.
That is a sign that with the ECB dominating monetary conditions for Europe, central banks in faster-growing economies might need to consider whether a narrow focus on consumer-price gains is the best measure of their success.
“Competitive devaluations used to be about getting more growth and now we’re trying to get more inflation without that having anything to do with the underlying economy,” said Anatoli Annenkov, an economist at Societe Generale SA in London. “That shows the desperation we’re in.”
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