REPEAT: MNI: Forex Volatility "Critical" To ECB, Need Prudence

Repeats Story Initially Transmitted at 09:50 GMT Feb 13/04:50 EST Feb 13

--Current Euro Levels, Volatility Not An Issue: Eurosystem Source

     LONDON (MNI) - Although current forex levels are not a source of concern to

the European Central Bank, euro volatility is a factor that could jeopardise

meeting inflation targets in the short run, and that calls for additional

prudence in recalibrating monetary policy, a Eurosystem source told MNI in

exclusive comments.

     "The exchange rate outlook can put a downward pressure on inflation and

therefore constitutes a critical element that the ECB's Governing Council is

closely monitoring," the source said.

     Despite stressing that the ECB was nearing its target of securing a

sustained return of inflation rates towards levels that are below, but close to,

2%, negative repercussions from the exchange rate could impact on the exact

timing.

     "We are confident that our set inflation objective will be met though it is

not yet clear when exactly in the short run, and looking at the current exchange

rate curve, this pushes us to be all the more prudent in avoiding an abrupt

unwind of monetary policy ahead of time," the source said.

     --CURRENT LEVELS FINE

     According to the source, at present levels the euro-dollar exchange rate

pattern "is not a source of concern and if it stays this way I believe it will

not cause any significant issue".

     A problem would arise in the longer run, however, if the exchange rate

becomes uncontrolled, with the risk of triggering a bubble on forex markets

caused by a potentially excessive euro appreciation.

     This is why the ECB's communication can play a major "buffer" role.

     "Given the high sensitivity of forex markets to monetary policy

announcements it is paramount that the ECB's communication be prudent, aimed at

avoiding such a risk, even if the scenario's evolution also largely depends upon

the Federal Reserve's moves," the source noted.

     The source argued that even if the euro exchange rate is not among the core

objectives of the ECB's mission, it can nonetheless have significant

repercussions on the transmission of monetary policy and, ultimately, on

reaching price stability.

     "All developments that are not triggered, and therefore controlled, by

macroeconomic factors can make it harder to reach our goal in the short run,"

the source said.

     In the last year, the euro has risen more than 15% against the dollar,

making oil imports into the euro zone cheaper with the effect of keeping core

inflation low.

     --INFLATION JAWBONING

     But if the ECB can do nothing "directly" against an uncertain exchange rate

outlook, explained the official, it can play a significant "indirect" role in

giving emphasised attention to the euro appreciation effects on defining an

exact schedule for the quantitative easing (QE) tapering.

     "Prudence means also taking into account that the QE exit remains

conditioned to several factors -- mainly the eurozone outlook and reached

inflation targets -- and that if these are not met, monetary policy must

continue to be accommodative," the source said.

     No date has yet been set for QE's termination: "It could happen in

September, or beyond that date, in any case we will cross that bridge only once

we get there," the source added, stressing that the QE exit must be "soft and

gradual", not hard.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com