A further rise in the euro would be a “risk to both growth and inflation”, according European Central Bank policymakers, who fear that eurozone inflation will remain in negative territory until the end of the year.
The high level of uncertainty about the single currency bloc’s economic outlook makes the case for keeping “a free hand” in how the central bank responds to the pandemic, members of its governing council said at its most recent meeting, according to minutes published on Thursday.
The meeting which took place last month left interest rates and the ECB’s stimulus programme unchanged.
But “given the openness of the euro area economy, [governing council] members considered that a further appreciation of the exchange rate constituted a risk to both growth and inflation”, according to the minutes.
It was the pace of the euro’s appreciation, rather than the level of the exchange rate, “that could become a concern”, governing council members said.
The euro is up 10 per cent against the dollar since its low for the year in March.
Its appreciation “had a material impact on the inflation outlook in the September ECB staff projections” and “the recent volatility in the exchange rate of the euro required careful monitoring with regard to its possible implications for the medium-term outlook for price stability”, policymakers noted.
The eurozone slid into deflation in August for the first time in four years; headline consumer price inflation was minus 0.3 per cent in September, the most recent reading.
Low oil prices and the temporary reduction in VAT rates in Germany implied that the eurozone headline inflation rate would remain negative “for the rest of 2020”, according to the minutes. Even over the medium term “inflation was expected to remain persistently low” because of the appreciation of the euro, weak demand and lower wage pressure.
Eurozone inflation will rise from an average of 0.3 per cent over the course of this year to 1 per cent next year, the ECB forecast last month — up from its earlier forecast of 0.8 per cent price growth in 2021, but still well below its target of below, but close to, 2 per cent.
“The case was made for keeping a ‘free hand’ in view of the elevated uncertainty, underpinning the need to carefully assess all incoming information, including the euro exchange rate, and to maintain flexibility in taking appropriate policy action if and when needed,” the minutes said.
Governing council members noted that inflation that ran persistently below target “posed a risk to the perceived ability and determination of the ECB to deliver on its mandate”.
The minutes “suggest that the ECB is more alarmed about inflation than we originally thought”, said Carsten Brzeski, global head of macroeconomics at ING.
Incoming data indicated “a strong rebound in activity”, after the unprecedented output contraction in the second quarter but governing council members also highlighted many sources of risk to the recovery, including the probability of a no-deal Brexit “which seemed to be increasing” and the resurgence of the virus.
The minutes were published as new data showed that Germany enjoyed stronger than expected exports growth for August, suggesting that the eurozone’s largest and more export-oriented economy was supported by the improved global trade outlook.
The extent of Germany’s economic outperformance was laid bare on Thursday by separate data showing that only 8 per cent of the country’s extended workforce were unemployed or underemployed in the second quarter, the height of pandemic-related lockdowns. The figure was two or three times higher for France, Italy and Spain.