The euro exchange rate is quite a puzzle. At the beginning of the year, forecasting the euro-dollar relationship seemed easy. It was assumed that the Federal Reserve would raise its key interest rates while those of the ECB would remain unchanged. With higher short-term rates for Americans, the euro should have weakened. Indeed, the differential between key monetary policy rates widened by fifty cents in favor of Americans, but the exchange rate of the single European currency went exactly in the opposite direction to what was expected.
From the end of 2016 to the day after the German elections last September 25th the euro gained about 13 percent against the US dollar and over 5 per cent against the aggregate of the nineteen currencies relating to the main trading partners of the Monetary Union. At the moment the exchange rate of the euro therefore does not seem to depend on the relative trend of monetary policies on the two sides of the Atlantic.
Good to know, given that the horizon over the next few quarters sees American rates continue on the gradual upward path associated with the return from the so-called "Quantitative Easing", while decidedly longer times are looming for any increases in the reference rates in Europe. The differential between short-term rates will widen further, but this may not be enough to give the euro a major reverse.
The strength of the European currency must be justified by other factors. Firstly, as noted in the latest ECB Economic Bulletin, there is improving growth prospects in the euro area. In the second quarter of this year, the trend rate of growth of the Eurozone's GDP came to equal the annual growth rate of the United States, standing at just over two percentage points. It is not a cyclical accident, but the fruit of a long march that has been going on for seventeen quarters. It is also the result of a European recovery model that is certainly more sober than the American one, at least in terms of the use of "deficit spending".
Behind the relative strength of the euro is growth that improves with little further debt. There is also a reflection of the so-called "safe assets shortage", of the scarcity of low-risk financial assets which increasingly conditions the global economic and financial equilibrium. In a world where populations age, debts continue to grow and new financial regulations push in the direction of higher standards of stability, the demand for safe assets systematically tends to exceed supply.
It is what Ricardo Caballero, an eminent academic of the Massachusetts Institute of Technology, and other scholars have recently defined as "the safety trap". There security trap it is a powerful structural element which on the one hand pushes down the yields of financial assets deemed safe and at the same time determines the appreciation of the currencies of the countries and areas which issue these assets.
The euro appreciates because the single currency area is seen as a less indebted and relatively safer haven for global financial investment. In support of this hypothesis we could cite the recent data from the Bank for International Settlements which, in the first quarter of this year, put the overall debts of Americans at over 47 trillion dollars against "just" 31 trillion dollars of debts for the total households, businesses and public administrations in the euro area.
Daughter of a newfound economic growth and a global preference for security, the strength of the euro risks turning from a virtue into a vice, to become a dangerous trap from a mere puzzle. An excessively strong euro staves off the return of inflation at levels in line with the monetary authorities' medium-term objectives. If not balanced by major improvements in productivity, excessive exchange rate appreciation it damages the competitiveness of our exports.
What to do? To rebalance the exchange rates of the single currency, there is no need for cyclical corrections of a monetary type. Instead, one would be needed structural change in terms of completing the economic and monetary union. Paradoxically, it would help to moderate the strength of the euro and defend the competitiveness of European exports an important injection of domestic demand, qualified and forward-looking, aimed at increasing the development potential of the monetary area through an investment plan in common infrastructure.
A plan capable of correcting the excess dependence on exports of the European growth model tested so far. A plan to be financed and carried forward with common and shared resources, as part of a project to create a central budgetary capacity in the euro area. A euro that is too strong is the symptom of a weak Europe because it is the expression of an economic and monetary union that is still incomplete. It is up to us to take note of it in order to find a lasting remedy. Even after the outcome of the German elections.
