Monday, November 16, 2009

EUR-USD: To Exit or Not to Exit, that is the Question

FX Briefing

  • Policymakers seek to reassure
  • Eurozone growing again
  • Start of exit strategy?

As far as US monetary policy is concerned, the answer to this question became fairly clear this week. The weak labour market data had already prompted speculation that an exit from the ultraloose monetary policy was still a long way off. This week, comments from several US policymakers confirmed this impression, pushing the dollar down further. EUR-USD rose to 1.5048, thus coming within a whisker of hitting a new 15-month high, but dropped again later to 1.49. The British pound also lost ground, after BoE governor Mervyn King had not ruled out additional quantitative measures. Cable fell by over 2.5 US cents temporarily to 1.6516, but strengthened again towards the end of the week to almost 1.67.

All the uncertainty about a possible start to an exit from the expansionary monetary policy, has thus vanished into thin air. Both Janet Yellen, president of the San Francisco Fed, and Richard Fisher of the Dallas Fed expressed doubts as to whether the present upswing was sustainable. Given high unemployment, low wage growth and dependence on government economic stimulus measures, an expansionary monetary policy would have to be maintained for some time to come. The Bank of England governor spoke even more bluntly on the release of the inflation report. As the economic situation remained fragile, he said, the central bank was keeping an open mind over whether to implement further measures to boost the economy in addition to the recent expansion of the asset purchase programme. Even Bundesbank president Axel Weber, whose thoughts on possible exit strategies had unsettled market participants the previous week, struck a very dovish tone this week: although the financial markets had stabilised significantly and most countries were now out of recession, the recovery was still fragile and it was thus too early for an exit from expansive monetary and fiscal policy measures.

The fact that the worst is over in the eurozone was underlined by the economic data. In the third quarter, all countries except Spain posted positive GDP growth rates again. In Germany, GDP actually increased by 0.7%, and the strong production figures suggest that growth is set to be robust in the coming quarter too. Italian GDP growth was almost as strong. But growth in France and the Netherlands turned out to be much weaker. In the euro area as a whole, gross domestic product rose again by 0.4%; the first increase after five consecutive declines, some of which had been very steep.

In the eurozone, discussions on an exit from expansionary monetary policy are likely to heat up again in December in the run-up to the important ECB governing council meeting. According to Bundesbank president Axel Weber, the gradual removal of support measures hinges on the situation in the financial sector. As the central bank has acknowledged that things in this field have stabilised significantly, we are expecting the ECB to at least announce the start of an exit strategy on 3 December. If it does in fact turn out to be the first major central bank to do so, this is likely to give the euro an additional boost.

In the coming week, policymakers will have enough opportunity to give some indication of their future plans. They will all be meeting up at the 12th Euro Finance Week, where the restructuring of the financial sector will be discussed.

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