In recent months, the euro’s appreciation has dominated financial markets. Since the start of the year, the euro has climbed roughly 15% against the US dollar and about 7% in nominal effective exchange rate terms. Even since the ECB’s June meeting, the euro’s effective exchange rate has risen another 2%. Although there has been some levelling off recently, the stronger euro is now a clear concern for policymakers. While the overall impact may seem modest, current exchange rates – if sustained – would mean the ECB’s inflation forecasts for this year and next would be slightly lower than anticipated in June.
Historically, the ECB has been reticent about exchange rate movements, typically asserting that it has no explicit exchange rate target and considers the euro’s value as just one among many policy transmission channels. That’s why the recent flurry of comments from ECB officials about the stronger euro has been so surprising. Vice President Luis de Guindos even called levels above 1.20 USD/EUR “tricky and complicated.” It’s worth remembering that it’s not a specific level, but the pace of appreciation, that usually worries the ECB.
In 2004, then-president Jean-Claude Trichet described a rapid move from 0.87 to 1.30 USD/EUR as “brutal.” His successor, Mario Draghi, was less dramatic but still noted that exchange rate strength amid low inflation was a serious concern. Next week, it’s likely the ECB will take a cautious tone, downplaying the currency’s level but noting its potential to fuel disinflation.
There’s another complication: President Donald Trump’s latest threat of 30% tariffs on European goods. In June, the ECB’s baseline scenario assumed just a 10% tariff, and even the downside scenario only went up to 20%. A 30% tariff would be more damaging to the eurozone economy, even if European retaliation eventually pushed inflation higher.