ECB officials expressed concern over risk of euro overshoot

[FRANKFURT] European Central Bank officials said they're worried that the euro might strengthen more than justified by the currency bloc's economic upturn.

"While it was remarked that the appreciation of the euro to date could be seen in part as reflecting changes in relative fundamentals in the euro area vis-a-vis the rest of the world, concerns were expressed about the risk of the exchange-rate overshooting in the future," an account of the July 19-20 policy meeting published by the ECB showed on Thursday.

The single currency fell more than a quarter of a cent after the report, before rebounding to trade at US$1.1701 at 2:03pm Frankfurt time. That's still down 0.6 per cent on the day. It has gained 11 per cent against the US dollar this year and 17 per cent on a trade-weighted basis as an economic recovery spreads through the 19-nation region.

A too-strong euro would undermine efforts to restore price stability in the euro area, highlighting the challenge policy makers face as they prepare to discuss a gradual exit from monetary stimulus. While economic growth is proving to be robust and increasingly broadly spread, inflation remains significantly below the ECB's goal.

"The point was made that, looking ahead, the Governing Council needed to gain more policy space and flexibility to to adjust policy and the degree of monetary policy accommodation, if and when needed, in either direction," the account showed.

ECB President Mario Draghi is scheduled to give two speeches next week, including an appearance at the US Federal Reserve's annual symposium at Jackson Hole, Wyoming, before the Governing Council next meets to set policy on Sept 7.

At their July meeting, policy makers also discussed making "incremental" changes to their forward guidance, though they eventually decided to keep their policy wording unchanged.

"Postponing an adjustment for too long could give rise to a misalignment between the Governing Council's communication and its assessment of the state of the economy, which could trigger more pronounced volatility in financial markets when communication eventually had to shift," according to the account.

The region's economy gathered pace in the second quarter, growing 0.6 per cent from the first three months of the year. Euro-area inflation held at 1.3 per cent in July - enough to argue that deflation risks have disappeared, but too little to meet the ECB's goal of just under 2 per cent.

Officials remarked on a lack of conclusive evidence that underlying inflation is on a sustained upward trend, even though there are some tentative signs of a pickup. They noted the need to look through transient volatility in the headline rate, saying that "to this end, it was important to ensure that inflation expectations remained well-anchored."

The Governing Council stressed that the "overall degree of accommodation was determined by the combination of all the monetary-policy measures," even though asset purchases continued to be a "key instrument" if an adjustment of the policy stance was needed. "In this context, it was also suggested that the stock versus flow effects of the asset purchases be considered."

Policy makers stressed that a "steady approach" to signaling shifts in its stance was important. "The view was widely shared that prudence was warranted with regard to the Governing Council's communication on the possible timing of its deliberations on the future course of its monetary policy."

At his press conference after the policy meeting, Mr Draghi said officials put off discussions about the future path of quantitative easing until after the summer. Asset purchases are currently scheduled to run at a pace of 60 billion euros (S$96.2 billion) a month through the end of the year. Economists surveyed by Bloomberg predict a nine-month tapering to start in January.

Mr Draghi said the repricing of the exchange rate had received "some attention," without pushing back against the currency's strength. The meeting was the first since he told an ECB conference in Sintra on June 27 that reflationary forces were at play in the euro area, arguing that a continued recovery would allow the central bank to scale back stimulus. His comments then sparked a rally in the euro.

BLOOMBERG