Exogenous shock from artificially high euro

For the first time the ECB has admitted that disinflationary pressures present a problem for the central bank. Draghi is blaming the downward pressures on prices in the Eurozone on the unusually strong euro.

WSJ: - "The strengthening of the effective euro exchange over the past one-and-a-half years has certainly had a significant impact on our low rate of inflation and, given current levels of inflation, is therefore becoming increasingly relevant in our assessment of price stability," Mr. Draghi said Thursday in a speech in Vienna.

Indeed the euro has been strengthening beyond most analysts' expectations.

EUR/USD (source: Investing.com)

The euro's lofty levels, combined with softening demand from China (see post), is creating headwinds for the euro area. Part of the problem is that a good portion of the Eurozone's recovery has been driven by exports rather than domestic demand. Moreover, the yen's relative weakness is not helping matters, as Japanese exporters have a pricing advantage over Germany.

The confluence of the euro's strength and weak domestic demand is exacerbating disinflationary risks in the Eurozone - as seen in today's German CPI number.

Source: Investing.com

Ironically some of the euro rally is rumored to be the result of China's rebalancing its FX reserves toward the euro, trying to diversify out of the US dollar. That's driving up the euro to levels not justified by the fundamentals.

CNBC: - "While the technical outlook and European domestic fundamentals look quite shaky for the single currency right now, there could be one external factor that may help to prop up the single currency in the face of these challenges: China," said Kathleen Brooks, research director at Forex.com.

The timing for Draghi is terrible. The ECB has been arguing for some time now that disinflation in the area is transient. But this artificial euro strength could be creating an exogenous shock, potentially dampening the area's nascent recovery and putting further downward pressure on prices.

SoberLook.com

From our sponsor: