Looming trade wars and higher euro likely to hamper ECB’s plans

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trade wars and higher euro

Concerns start to rise on the growing uncertainty in global trade which was not so long ago touted as one of the reasons for helping the Eurozone and especially German imports. The Eurozone posted one of the fastest growths in 2017 in nearly a decade led by higher imports with countries such as Germany running a trade surplus.

However, the optimism is in for a reality check as the European Central bank starts to address the uncertainty at various levels. The most important being the potential for the trade wars that could quickly escalate and hinder growth in the Eurozone.

Although the ECB’s monetary policy meeting held in early March was seen as hawkish by central bank watches, the ECB took a more cautious approach as the ECB President Mario Draghi signaled that trade wars could hamper growth and could also hinder confidence on the inflation path which still remains weak.

A few months before, the markets were hopeful that; following the ECB’s taper announcement in October 2017, the central bank was on path for monetary policy normalization. The ECB signaled that new QE purchases would run at 30 billion euro from January 2017 through September 2017.

In recent times, the ECB was seen toning down its hawkish rhetoric. Although the central bank had removed its reference towards keeping monetary policy accommodative from the official statement, the press conference after the March ECB meeting saw Draghi reiterating that the central bank remains committed to reaching the inflation target. This meant even at the cost of increasing QE or extending the duration of the bond purchases.

The ECB Watchers conference held two weeks ago saw Draghi noting that the initial effects of a potential trade war would have limited impact on the Eurozone. However, he cautioned that there are considerable risks of a follow-through effect.

Speaking at the conference, Draghi said, “There are potential second-round effects that could have much more serious consequences. These include the risk of retaliation across other goods (…) and the potential for negative confidence effects, which would weigh on business investment in particular.”

With President Trump following through with imposing tariffs on steel and aluminum, it has stoked concerns that the U.S. President could further his agenda on protectionist policies.

The euro exchange rate has also appreciated strongly in recent months, which is also starting to become a concern among policy makers.

Although the ECB has refrained from making any direct statements that could impact the exchange rate, it was evident from the fact that ECB officials noted that the higher exchange rate would put downward pressure on inflation.

Recent inflation data showed that consumer prices eased in February, rising just 1.1%. Although core inflation rate has remained the same, the weak trend in consumer prices shows that the ECB is likely to remain patient and manage monetary policy until there are clear signs of inflation pressures building up.

Trump’s first action on trade, which is imposing the tariffs, will come into effect this Friday. Upping the ante, the U.S. President also threatened to impose further levies on car imports from the EU. This is expected to hit the German economy which relies significantly on automobile exports to the U.S

An initial glimpse of the uncertainty was clear from last week’s data. The German ZEW economic sentiment fell to an 18-month low in March. Survey respondents cited the uncertain policies from the U.S.

The ZEW President Wambach cautioned that the data showed that the German growth could not be taken for granted. He said, “Concerns over a US-led global trade conflict have made the experts more cautious in their prognoses.”

For the moment, the euro currency looks unfettered by the challenges that lie ahead. However given the uncertainty which is definitely not in the favor of the common currency, the ECB could be expected to remain flexible on its monetary policy in the months ahead.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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