How to Talk Down An Exchange Rate
One of the most interesting verbal interventions in modern times happened recently – the ECB talking down the EURUSD exchange rate from 1.20. This is not the first time when central banks deliver verbal interventions, scared of the effects of a stronger currency.
In fact, central banks in emerging markets have a habit of doing so. But in developed economies, a central bank thinks twice if it wants to do so. Retaliation from the other party is not only possible but probable.
Orchestrated Efforts from the ECB
Before discussing what the ECB did, it is worth looking at a different example. Several years ago, the Reserve Bank of Australia (RBA) had a different governor. The strength of the Australian dollar weighed on its exports and the RBA intervened several times, even indicating what an appropriate exchange rate level is. For instance, at one point, the AUDUSD traded above 0.90, and the RBA indicated that 0.70 is a more appropriate rate. Guess what – the AUDUSD swiftly dropped to 0.70 in the period that followed.
At first, the ECB hinted that the 1.20 is too high an exchange rate that it could tolerate. Phillip Lane, the ECB executive board member, said that the euro-dollar rate matters days before the ECB meeting in September. The EURUSD pair quickly dropped a couple of big figures.
Next, the ECB included the exchange rate concerns in the introductory statement. It made it clear that the earlier verbal intervention was no mistake.
Moving forward, the ECB Vice President de Guindos offered an interview with a Spanish financial publication. Once again, he reiterated that the exchange rate, while not targeted at a specific level, affects inflation if the currency is perceived as too strong.
In other words, there is a “modus operandi” at all levels and talking down the currency is the new mantra at the ECB. In a way, it is understandable because the ECB faces a difficult time – the coronavirus pandemic and the economic recession that followed caught the central bank with the deposit facility rate already below the zero level. How to ease further without using unconventional measures?
In the world of central banking and currency trading, every detail matters. The price action, in the end, will force the ECB to calm down its message, if the EURUSD exchange rate drops to appropriate levels.
But what is an appropriate level?