ECB’s Mersch on Exchange Rate: ‘Very Attached to Multilateralism’

23 September, 2020

By David Barwick – FRANKFURT (EconoStream) – European Central Bank Executive Board member Yves Mersch on Wednesday highlighted the virtues of restraint when speaking of the exchange rate and said that while the ‘statistical’ impact of euro appreciation made close monitoring necessary, this did not represent a strategy change.

In an interview with Bloomberg, Mersch, according to a text made available by the ECB, said that economic prospects had ‘at least’ not worsened in the last three months, that the preponderance of risks now might be less negative than previously and that there was a chance of an outcome closer to the ECB’s best-case scenario.

Responding to the assertion that an interest rate cut could be an effective reaction to the strengthening of the common currency, Mersch said his first point would be that the ECB does not target the exchange rate.

He continued: ‘The second is that as Europeans we are very attached to multilateralism, and on exchange rates we have consensus language at the global level that has been valid for many years now, and that does not only speak about the exchange rates being in line with fundamentals but it also speaks about the volatility, excess volatility being disruptive.’

Still, he acknowledged, ‘it is obvious that the recent movement in the exchange rate has had statistical effects on some of our measures of inflation and production.’ The ECB’s strong commitment to price stability means it must ‘monitor very closely the effects of exchange rate developments on our efforts’, he said, ‘but this is by no way a change in strategy.’

Financial markets would be pleased if the ECB were to ‘buy up everything’, Mersch acknowledged. The ECB will decide about further action based on the entire Eurozone, ‘the shutdown in individual countries’ and data obtained since June, he said.

‘We are open-minded, but the open mindedness goes both ways’, he said. ‘We always insist on symmetry. If the situation should hugely improve, our reaction should be the opposite of a reaction to a deterioration and also different from a continuation along the baseline.’

Banks have ‘done their job’ in financing the economy, backed by public guarantees that eventually will come to an end, he said. ‘Our concern is to avoid cliff effects’, he said. Although the improvement in banks’ capital situation in 2Q balanced the deterioration of 1Q, the likelihood of further impairments means all policy areas are called on to ‘transform the cliffs into ramps’, he said.

Asked for his view of the current economic outlook, Mersch replied that since the ECB acted in June, ‘the least one could say is that things in the economy have not gone for the worse.’ Though incoming data are not always consistent, they generally indicate that the balance of risks ‘may still be somewhat to the downside but less so than it has been’, he said. The ECB did not move in September because developments were consistent with its central scenario, he added.

‘Looking also at new incoming information I think nothing is pointing to a further deterioration at least not on the front of prices and production’, he said, noting that this hinged on there being ‘no major deterioration on the health front.’ If the public health situation holds up, there may be ‘chances to come out a bit closer to the [ECB’s] upward scenario’, he said.

Besides the pandemic, financial amplification is a second source of uncertainty, but the array of policy measures by various authorities has been ‘very supportive’, he said. ‘And you have seen that the trough, which is behind us, has been a little bit less steep than forecast, and the rebound is now being revised slightly upwards.’

Complacency is unwarranted, Mersch said. The ECB’s programmes have been ‘extremely efficient’ and ‘need to continue.’

The degree of structural change triggered by the pandemic is hard to assess, Mersch said, but ‘for the moment it looks as if the downfall in prices might be attributed roughly 50% to the demand side and 50% to the supply side.’ However, he added, the dynamics involved can in each case change direction.

Uncertainty about the post-pandemic world implies closely monitoring incoming information, he said. ‘We better err on the side of prudence’, he said. ‘That means we have to provide ample liquidity to support the recovery amidst longer uncertainty.’ As signalled by the ECB, ‘asset purchases and TLTROs [targeted longer-term refinancing operations] have presently more traction than our traditional instruments’, he added.

However, he observed, the ECB has ‘never said that the interest rate is no more at our disposal’, and any decision will be preceded by ‘a holistic assessment of all our toolbox instruments’.

Mersch denied any direct awareness of a discussion about incorporating the flexible nature of the pandemic emergency purchase programme (PEPP) into the asset purchase programme (APP). The former has been ‘extremely efficient’, he said, ‘[b]ut it is an emergency instrument created because of the pandemic.’

‘We have stated that we have disenfranchised ourselves from a certain number of self-imposed constraints in view of the pandemic and in view of its exceptional nature and threat - and that means it must be temporary’, he said.

To prolong the PEPP beyond the pandemic ‘increases the risk of arbitrariness’, he argued, whereas the ECB has made public promises in courts about adhering to the Treaty and in particular respecting the prohibition on monetary financing.

‘So if you now say we have emergency instruments which do not need to respect these constraints, and we use them now also in our normal procedures, I do not know what the same jurisdictions would say in their future assessment’, he observed pointedly.