Attempts to talk down the euro unlikely to succeed;

As the value of the euro continues to rise gradually, we have heard some officials try to talk down the currency. Simon Smith of FxPro reminds us of the poor track record in moving the currency, and merely limited impact that such talk can have.  

In the interview below, Smith also discusses the chances of more steps from the Bank of Japan, the complications of forward guidance in the UK, the impact of bad weather in the US and more.

Simon has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining  FxPro  in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital.  He has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International.  Simon holds an MSc. in Economics from the University of London and a BSc. from Brunel University.

Both the ECB and other Eurozone official have a very bad track record in talking the currency up or down, which ultimately lead to the previous ECB President crowning himself “Mr. Euro” after the cacophony of verbal interventions from different officials during his time.   Even at the best of times for other currencies, verbal intervention only has limited and short-lived impact and usually as a re-enforcement of either a trend or a turn-around that is already underway and/or if the market is very short or long a particular currency, causing it to be wrong-footed. So even if we do see more of such comments, then they will be of only limited impact, especially as it has more been the dollar running the show recently.

This week’s meeting saw some minor measures extending and expanding existing lending programs, which had a modest impact on the yen.   The issue remains the reaction to the upcoming consumption tax hike in April and the impact that has on growth. Inflation has been rising, towards the 2% target. The challenge will be in the coming months, because the base effects from the strong rise March 2013 onwards will act as a strong downward force on the headline rate (because prices were rising rapidly a year ago).   As such, I still think there is a decent chance that we see some further action mid-year, as a means of keeping the economy on track in face of the consumption tax headwinds.

More often than not, the impact of such events tends to be over-stated. Firstly, looking at the payrolls data, the numbers for people unable to work owing to weather are high, but not as high as some of the peaks seen in previous years. This suggests that it is not exclusively down to the weather alone. Secondly, acknowledging that there are some impacts, they are invariably less than feared because we see offsetting factors (great business for those providing rock salt for roads) and also a degree of the lost output is also made up when the bad weather recedes. So I don’t see it derailing the recovery, just making it a little more uneven.

We’ve seen an initial reaction to the weaker than expected inflation data yesterday, which showed a move to below the 2.0% target level, with a further softening of rate hike expectations after the surprise rise in the unemployment rate this week. Inflation remains the BoE’s legally mandated goal, but there is no doubting that Carney has complicated things with the adjustment in forward guidance, so the impact of inflation data has been reduced, because policy is leaning on other factors, such as the output gap. Finding out where and what that is though is the holy grail of economics, so to my mind the BoE have confused more than clarified matters and I think the rise in interest rate expectations after the Inflation Report last week is in part a reflection of this uncertainty.

It’s difficult to generalise, because emerging markets are have different policy, current account and funding positions. Last year it was noticeable that those with more vulnerable funding requirements (reliant on overseas capital, preponderance of short-term debt) were being hit harder. This was not the case during the pressures seen in January. The fact is that emerging markets were a key beneficiary of the dollar liquidity created by the Fed’s QE program so it is to be expected that they will have to give something back when the program is withdrawn. This has been the case both in the run-up to the tapering that never was in September of last year and also up to and after (in January) the modest tapering over the past couple of months.  I think we are still likely to see some pressure points, but as with January, I don’t see it evolving into a full-blown EM crisis. Many countries (especially in Asia) have learnt lessons from before and reduced their funding vulnerability, so it is the likes of South Africa, Turkey, Brazil and India that are still vulnerable to further downside.

Further reading:  Fed likely to taper little and often as underlying economic momentum remains firm