MNI POLICY: Fed's Faster QE Pushed Euro 6% Higher-ECB Paper

Quantitative easing can have significant, persistent effects on currencies' relative strength, a paper published by the European Central Bank found, arguing that more than half of the appreciation of the euro versus the dollar during the Covid-19 pandemic was due to the Fed's QE programme outpacing the ECB's.

"A typical expansionary QE announcement by either the ECB or the Fed in the sample resulted in an increase in the relative balance sheet of about 20% over the next nine months, and, in turn, in a persistent exchange rate depreciation of around 7%," a team of ECB researchers concluded.

The Fed's balance sheet expansion during the Covid-19 pandemic, 16 percentage points more than the ECB's, fueled an appreciation of the euro vis-à-vis the US dollar of almost 6%, they added - equivalent to more than half of the actual appreciation between March and September 2020 of around 10%.

The paper, which does not represent the views of the ECB, found that changes in the "signalling channel" regarding expectations about the future monetary policy stance can also affect how the USD/EUR exchange rate responds to central bank asset purchase programmes.

"These are mainly transmitted through currency risk premia. But they also materialise through liquidity effects in money markets, signalling effects and, to a much smaller extent, limits to arbitrage in foreign exchange markets," it was reported.