The European Central Bank must keep its guard up against the risk of a sudden appreciation in the euro, according to Governing Council member Philip Lane.
“There’s no concern about the current level,” Lane, who heads Ireland’s central bank, said in an interview in Dublin. “But if it moves a lot within a short time interval then you have to think about the implications.”
The ECB has stepped up warnings against exchange-rate volatility in recent months as policy makers prepare the ground for ending their bond-buying program. The euro has gained almost 16 percent versus the dollar over the past year and while that’s partly due to the region’s economic expansion, a stronger currency also puts downward pressure on inflation and potentially saps the competitiveness of exporters.
The euro briefly spiked to the highest level since March 8 on Lane’s comments, before paring gains to trade little changed on the day at $1.2328 at 12:01 p.m. Frankfurt time.
Three years since starting the asset-purchase program, which is set to run until at least September and top 2.5 trillion euros ($3.1 trillion), the ECB remains well short of its inflation goal of just under 2 percent.
Lane said progress on reaching that goal looks promising. The 48-year-old, who last month dropped out of the race for the ECB’s vice presidency and is among the favorites to become its next chief economist, said wage settlements are showing improvement and companies are raising their markups.
“As these factors convert into higher inflation readings, our confidence that inflation will converge to the target over the medium term improves,” he said.
Reflecting that confidence, the ECB last week dropped its pledge to expand the monthly pace of bond purchases if needed. At the same time, President Mario Draghi stressed that buying will continue until inflation is firmly back on track toward the target. Updated economic projections showed price growth still undershooting two years from now.
Meanwhile, traders are bracing for an appreciation of the single currency. Based on a measure known as the implied volatility surface, the euro is more likely to trade above $1.27 than below $1.20 in six months. Analysts predict the currency to end the year at $1.26.
The ECB’s policy statement last week also reiterated a pledge to keep interest rates unchanged until “well past” the end of net asset purchases. That commitment has become too vague for some policy makers including Bundesbank President Jens Weidmann, who argue the Governing Council should be more explicit about when it plans to end purchases and tighten borrowing costs.
Officials are scheduled to hold their next policy meeting on April 26, though economists don’t expect another significant step toward unwinding stimulus until the following gathering in June.
For Lane, the current guidance on interest rates “makes clear” that there will be no immediate shift in policy, and the accumulated stock of purchases will be maintained by reinvesting proceeds from maturing bonds.
“Whenever net asset purchases come to an end, there will still remain considerable monetary accommodation baked into the system,” he said.