spending might not be that helpful, risking recession for economies. So, a competitive spiral develops as advantage seeking through weaker currencies starts up. China is often blamed for manipulating its currency through interventions and fixed rates, but others too have intervened using the option of looser monetary policy. With interest rates nearly or even at zero, central banks pushed quantitative easing. Te often feared printing of money may be used for buying debts or intervening in the currency markets.
With a new President at the top of the European Central Bank we recently experienced a change in the ECB’s policy. Te markets, initially surprised by a sudden cut in interest rates and market expectations, are anticipating another step. Well it seems there will be positive and negative impacts of policy easing by the ECB on the EUR exchange rate. A cut of interest rates on the one hand might undermine the Euro versus other major currencies. On the other hand the Euro can benefit from clear policy actions emphasizing continued confidence and viability of the EMU mechanism.
Recalling one of the consequences of quantitative easing is that the balance sheet of the ECB has expanded during the crisis. But whilst the balance sheet of the ECB has seen an increase of some 80%, the one by the Federal Reserve Bank increased by
some 230%, that of the Bank of England by some 205%, and that of the Swiss National bank by some 235%.
Room for maneuver
Te figures above should provide further room for maneuver within the Eurozone. Whilst comparing the US GDP debt of more than 100% to that of the EU zone of 88% the current pressure by rating agencies might be overdone – in particular when considering the current US deficit of 10.8%! Some rumours are explicitly naming political motives behind such actions. Other sources are clearly talking of a ‘War of Currencies’ between Europe and the United States. Within the past few years the EUR has managed to increase its portion of World reserves currency from 17% to 27%. A weak Eurozone would mean increasing support for the world’s largest economy, the United States.
Whatever we might consider the cause for the ongoing market swings, one thing is certain, the weak bank environment in the Eurozone puts pressure on some single countries, which is one of the rating agencies justifications for their recent attack on sovereign debt. But we also cannot completely negate the impact of countries seeking advantage through competitive currency policy. So Foreign Exchange will stay in the focus of monetary policy.
january 2012 e-FOREX | 21
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