Central bank intervention may not be the answer to euro’s strength

European central bankers have begun to express concern about the euro’s strength, after its 13% jump versus the dollar so far this year.

A strong currency reduces exports by making a country’s products more expensive in foreign-currency terms. And lower exports mean lower economic growth. Germany in particular is dependent on exports, which account for about 50% of its GDP.

In addition, with eurozone inflation at only 2% in June, some experts say a weaker euro is the cure to stimulate the economy. The eurozone economy grew only 0.3% in the first quarter from the fourth quarter.

“We should try to avoid any overshooting” for the euro on the upside, European Central Bank Vice President Luis de Guindos told Bloomberg earlier this month. A rise by the euro above $1.20 might constitute an overshoot, he said. The euro recently traded at $1.1690.

This picture has raised talk that the ECB might intervene in the currency market to push the euro back down. That would make European exports more attractive in foreign currency terms.

Why intervention looks unlikely

Despite the ECB’s wariness of euro strength, however, the central bank appears unlikely to intervene in the market. For one thing, traders and investors already are putting a cap on the euro. It has eased 1% against the dollar since July 1.

In addition, the ECB can continue to cut interest rates if it feels a need to ignite the economy. When it lowered its main rate to 2% last month, it indicated that was the end of its rate reductions for a while. But it can obviously change its mind whenever need be and resume its rate decreases. 

There is no guarantee that ECB intervention in the currency market would work. First, it would likely need to be coordinated with other central banks to be effective. That cooperation is hard to create outside of financial crises.

Currency history

Coordinated central bank intervention worked well in the 1980s, but the currency market was a lot smaller then. Daily currency trading volume was estimated at $50 billion to $150 billion for the 1980s, according to artificial intelligence service Grok. That rose to $7.5 trillion in 2022, according to the Bank for International Settlements. So central banks would have to throw in a lot of money to influence exchange rates now.

It’s also not clear that intervention against the euro would help the economy. A weaker euro would lift the price of imports, such as energy and commodities, in euro terms. This in turn could boost inflation and potentially limit economic growth. 

In addition, the euro’s recent dip could continue. Currencies can turn around quickly. If the U.S. economy grows substantially more than Europe’s, traders and investors may sour on the euro.

So doing nothing may turn out to be the ECB’s best policy.