By David Barwick – FRANKFURT (EconoStream) – The account of the European Central Bank’s policy meeting of 9-10 September, released by the ECB on Thursday, showed the Governing Council to consider the risk of a yet stronger euro to be a reason to avoid complacency and to convey to markets the possibility that further strengthening was not automatic.

According to the account, the view was expressed that the speed with which the common currency was gaining ground could be more reason for concern than its level, with a further appreciation seen as threatening both growth and inflation.

While highlighting the importance of asset purchases as a source of monetary accommodation, the account left open the door to further rate cuts and adjustments in the ECB’s refinancing operations.

The risk that the euro would rise further was considered in part a reflection of how monetary policy stances would evolve relatively across jurisdictions, the account said. ‘Against this background, it was considered important to avoid complacency and the perception among investors that the direction of exchange rate movements was a one-way bet’, it said.

Were the euro to appreciate further, this would amount to ‘a risk to both growth and inflation’, Governing Council members felt. Exchange rate developments were variously blamed for interrupting the trend toward easier financial conditions, for likely subdued near-term price pressures, and for having prevented a larger upward revision to 2022 core inflation.

The appreciation of the common currency was attributed to more relaxed risk sentiment and reduced safe haven flows, the report said. Despite having reached a level above that of 2018, ‘it was suggested that it was the pace of the euro’s appreciation, rather than the level of the exchange rate, that could become a concern’, the account reported.

There was no clear view reported on whether the trend was considered likely to endure, given high volatility and the possibility of the euro reversing course, according to the account. Still, the review of financial market developments included the observation that ‘market positioning remained tilted towards further euro appreciation, with net speculative US dollar positions against advanced economy currencies, including the euro, remaining sizeable.’

There was ‘broad agreement’ that the price-stability implications of the stronger euro needed ‘careful monitoring’. Governing Council members widely agreed that ‘it needed to be emphasised that while the euro exchange rate was not a policy target for the ECB, the external value of the euro was an important determinant of inflation developments in the euro area’, and had thus affected the updated staff projections.

With respect to the policy stance, the account reported the sentiment that ‘keeping a steady hand … was seen as most appropriate. At the same time, the case was made for keeping a “free hand” in view of the elevated uncertainty, underpinning the need to carefully assess all incoming information, including the euro exchange rate, and to maintain flexibility in taking appropriate policy action if and when needed. ‘

Governing Council members looked forward to incoming information over the next weeks, ‘which would provide improved visibility about how the various forces at play would influence the medium-term inflation outlook.’

Close monitoring was seen as warranted with respect to the pandemic, Brexit, the U.S. elections and national fiscal policies, the account said.

According to the account, the discussion of the policy stance endorsed the view that the entire envelope of the pandemic emergency purchase programme (PEPP) would need deploying so as to return to the pre-pandemic inflation path, ‘which was also in line with prevailing market expectations.’

‘It was seen as important to remain firm on previous announcements regarding the overall PEPP envelope, which underpinned the Governing Council’s commitment to bring inflation back to levels in line with its aim’ the account said. Still, the monthly pace could be slowed with easing market tensions, it added.

The account confirmed monetary authorities’ oft-repeated willingness to adjust their policy stance. ‘While the PEPP was currently seen as the primary instrument for providing additional monetary policy accommodation, it was noted that further cuts in policy rates and changes to the conditions of the TLTROs were also part of the toolkit for providing additional monetary policy accommodation, if necessary’, the account said.

According to the meeting account, the Council viewed developments since the previous staff projections as having been ‘broadly in line’ with these. While the balance of risks was seen to tilt downwards, mainly because of high uncertainty surrounding the pandemic, a look backward showed the 2Q decline in output to be less serious than expected, with 3Q seen as probably better than anticipated.

The only small revision to the inflation outlook was attributed to the upside impact of ECB policy measures on underlying price pressures, while it was also ‘underlined that inflation remained below the Governing Council’s aim over the projection horizon, notwithstanding ample policy support.’

At least one member felt that the updated staff projections for inflation were too optimistic, predicting subdued wage developments in the context of weak labour markets. Against this, it was noted that fiscal policies not yet reflected in the forecasts would normally support inflation.

The projection of 2022 HICP of 1.3% was characterized as being at ‘some distance from levels in line with the Governing Council’s inflation aim’, while subdued expectations ‘posed a risk to the perceived ability and determination of the ECB to deliver on its mandate’, with the possibility of ‘a renewed downward trend in inflation expectations.’