Effective FX Rate Weakness A Growing Headache For ECB (1/3)

The nominal EER-42 euro effective exchange rate, which the ECB macroeconomic projections takes into account, has fallen by about 8% from the basket's most recent peak in December 2020.

• While the move through USD parity to a fresh post-2002 low will again put ECB policymakers on notice (Villeroy said back in May at around 115.5, a little above the current 113.6 level, that "a euro that is too weak would go against our price stability objective"), the 8% drop in the effective index (and under 6% Y/Y) may not be enough of a fundamental reason to engage in significant verbal intervention to shore up the euro.
• The index would have to fall about 11% further to reach its low of the last decade (in 2016), or around 27% further to reach its all-time low in 2000.
• But in any case, the ECB's assumptions for the euro have proven too optimistic. The current effective exchange rate is 113.6, vs the ECB's June 2022 assumptions of 116.7 in 2022, and 116.1 in 2023-24 (reflecting assumptions of EURUSD 1.07 this year and 1.05 thereafter).
• "The depreciation of the euro effective exchange rate" was one of the factors cited for June's upward revisions to the ECB's HICP expectations.
• While it's far from the primary factor (paling in comparison to soaring energy/power prices), the downward move in the euro since June will be another factor in future upward inflation forecast revisions, due largely to the impact on imported inflation.

Source: ECB, MNI