The minutes from the European Central Bank’s latest monetary policy meeting reveal anxieties about nations manipulating their currencies for competitive gain.
According to the ECB minutes, which were released today, “A number of remarks were made about recent exchange rate developments.”
It was noted in the minutes that while the euro exchange rate is not a target of ECB policy, movements in the exchange rate are deemed important insofar as they can affect the outlook for growth and inflation in the euro area.
The euro appreciated for much of 2017, as sentiment towards the euro area grew more positive following the Dutch and French general elections and as the region’s economy continued to improve.
The minutes say that it was argued that an exchange rate appreciation linked to positive developments in domestic demand could be expected to have a lower pass-through to inflation, as firms would likely use the strength of the economic situation as an opportunity to rebuild their profit margins, which they had reduced during the crisis.
“However, more recently the euro’s appreciation also reflected other factors, including communication on exchange rates and on the monetary policy outlook across major currency areas. In such cases, the pass-through to inflation could be stronger,” it says in the minutes.
Apparently, it was also pointed out during the meeting that the bilateral exchange rate of the euro against the US dollar had changed more than the euro’s nominal effective exchange rate.
“This had led market participants to attribute recent exchange rate volatility more to the weakness of the US dollar than to the strength of the euro. However, explaining the US dollar weakness was not straightforward, given the strength of recent data releases and the fiscal and monetary policy outlook in the United States. This also had to be taken into account when considering the consequences of the exchange rate appreciation for the euro area economy. In addition, an appreciation relative to an invoicing currency such as the US dollar could be more important for the strength of the pass-through than suggested by its weight in the effective exchange rate,” according to the minutes.
The effect of this on the economy of euro area will depend on the extent and persistence of the exchange rate appreciation, added those present at the meeting.
Now, here comes arguably the key quote from the ECB minutes:
“Concerns were also expressed about recent statements in the international arena about exchange rate developments and, more broadly, the overall status of international relations. The importance of adhering to agreed statements on the exchange rate was emphasised, such as that included in the October 2017 communiqué of the 36th meeting of the IMF’s International Monetary and Financial Committee, which stated that excessive volatility or disorderly movements in exchange rates could have adverse implications for economic and financial stability, and that members would refrain from competitive devaluations and would not target their exchange rates for competitive purposes.”
The minutes show that this subject was raised again later in the meeting, following a broad agreement from the members present to convey the Governing Council’s concerns about the recent volatility in the euro exchange rate, which represented a source of uncertainty that had to be monitored with respect to its implications for the medium-term outlook for price stability.
“In this context, it was also seen as important to reaffirm the agreed G7 and G20 exchange rate language, which entailed the commitment to market-determined exchange rates and refraining from targeting them for competitive purposes,” it says in the minutes.
Although the ECB did not specify exactly which countries it was concerned might be targeting competitive devaluations in their currencies, given the earlier comments about the current weakness of the US dollar even as data shows the US economy to be in rude health, it is possible that this is an allusion to comments made by US Treasury Secretary, Steven Mnuchin, in January.
That was when Mnuchin was widely quoted in mainstream media outlets present at the World Economic Forum in Davos as stating that a weaker dollar would be beneficial to the US in terms of trade opportunities and that the currency’s short-term value is not a concern for the current US administration. This caused the euro to jump to its highest level against the dollar since 2014.