A stronger euro is a double-edged sword for the ECB

Currency dynamics and inflation is always a tricky ordeal to debate and/or navigate through. But for most major economies, currency movements are rather controlled and arguably play a small role in terms of influencing price pressures. The same goes for the euro area, or so at least that is what the ECB has been preaching over the years.

If we put that aside, what does the recent rise in the euro mean for the central bank and also the economy in general? Let’s take a look.

First off, let’s check on how the euro is performing in 2024 as a whole. With the dollar as the benchmark, the single currency is actually the second best performer among the major currencies.

And even so, the euro is just up nearly 1% only against the greenback. It feels rather surprising to see that, no? That especially given the dark outlook surrounding the dollar recently.

Going back on topic, how does this really impact the euro area economy if at all?

Well, considering the state of the manufacturing sector – especially Germany – a stronger euro is not exactly a helping factor in that regard. Demand conditions are weak and foreign demand is also struggling, not least with China’s worries. But with manufacturing already struggling, a stronger currency will make for more expensive exports and not help with the industry plight.

It’s certainly not too strong a factor yet considering the changes as seen above. However, every small thing counts especially when the economy is starting to show signs of a struggle again in Q3.

The ECB having to cut rates at a quicker pace might help to limit this as a factor in general. But their main battle is still on the inflation front, unlike the Fed.

As such, a stronger euro might be welcome slightly especially since it looks like we’re encountering a couple of bumps along the way in the disinflation process. That despite the argument above from the ECB that the exchange rate isn’t quite as important a factor in influencing prices.

Anyway, the latest CPI report in July here shows that price pressures aren’t exactly worsening but they’re not coming down all too quickly and convincing either.

If there is a tick up in inflation, even if due to base effects, towards year-end then that could give reason for the ECB to pause once again.

And that might invite further strength to the euro, with traders having now priced in ~66 bps of rate cuts in the next three meetings to December.

In turn, that feeds back into the cycle of putting more pressure on the manufacturing industry. And it all circles back to heaping pressure on the ECB again in having to chase rate cuts amid a stuttering economy.

This article was written by Justin Low at www.forexlive.com.