Dec 1, 2014 5:44 AM
Weak euro becoming key to Europe's recovery
The Associated Press
FRANKFURT, Germany (AP) If that creme brulee in a Paris cafe seems a bit cheaper for U.S. tourists next summer, they may have the European Central Bank to thank for it.
Economists are lowering their forecasts for the value of the euro on expectations that the ECB will make good on its promises to provide more support to the eurozone economy if it needs it. Central bank stimulus tends to weigh on a currency.
Ultimately, the euro's drop itself could be the biggest boon to the economy as it helps exporters and encourages tourism.
ECB officials are debating whether to provide more stimulus, perhaps in the form of large-scale purchases of government bonds. Analysts think such a program which is called quantitative easing and has been used by the U.S. Federal Reserve will not be decided at the next governing council meeting on Thursday but could come in the first months of next year. ECB President Mario Draghi has been emphatic recently about the bank's willingness to do more.
Yet the ECB may already have achieved some of the most powerful effects of any future stimulus as the currency is falling in anticipation of action.
Against the dollar, the shared currency was below $1.25 on Monday, from near $1.40 in early May. Experts say it could fall further, to as low as $1.10, over the next year or two.
Stefan Schneider, chief German economist at Deutsche Bank, estimated that a 10 percent depreciation in the euro's value against a group of key currencies adds as much as 0.8 percent to economic output in the 18-country eurozone.
That is putting the euro front and center, particularly as some analyst question how effective the ECB stimulus measures would be through other channels.
For instance, bond purchases are meant to drive market interest rates down, making life easier for companies, consumers and governments. Yet bond yields are already very low and it's not clear how much further the ECB can drive them down.
"The ECB doesn't want to be seen as manipulating the exchange rate, so it's an intended side effect, I would call it," said Schneider. "And given the weakness of domestic demand ...I think a little bit more tailwind from the external side, that's what the ECB is looking for. "
Deutsche Bank thinks further ECB stimulus could send the euro as low as $1.15 by the end of 2015.
WAITING FOR JANET
A key player in the euro's exchange rate is the Federal Reserve.
The Fed and its chair, Janet Yellen, have ended their own bond purchase program and are considering when to raise interest rates, just as the ECB is looking to push them lower.
That could pull investors out of European government bonds and into dollar-denominated investments. The result would be stronger demand for dollars among investors, and a further rise in the dollar's exchange rate with the euro.
HOW LOW CAN IT GO
U.S. Treasury Secretary Jacob Lew has urged countries not to deliberately try to weaken their currencies to gain trade advantages. But in Europe's case, U.S. officials would be relieved to see an economic recovery in the region. Stagnation in Europe, a key trading partner, has been weighing on the U.S. and global economies.
"What's most important for the U.S. is getting Europe back on track, and I don't think Europe can do that with a $1.25 euro," said Mark Zandi, chief economist at Moody's Analytics. "It certainly couldn't do it with a $1.40 euro."
Zandi said the euro could slide to $1.10 by the end of 2016.
A European rebound would be "a major positive for the U.S.," he said. And that should wipe out any U.S. worries about the euro's weakness, for now.
A weaker euro against the dollar wouldn't hurt U.S. exports to Europe that much. U.S. multinationals can often produce where they sell, eliminating currency effects.
What a weaker euro would do instead is shrink euro earnings when they're translated back into dollar terms for quarterly earnings purposes. Unexpected shifts can make it harder for corporate executives to reach profit targets set in dollars meaning an explaining job to investors.
In historical terms, the euro's recent drop is not yet that large and could go further. While that will be positive for Europe, "there's very little impact on the U.S. economy," said Zandi.