ECB: EUR REER At Strongest In A Decade, ECB Views Mixed On Further Strength

The EUR real effective exchange rate is at its strongest in a decade, currently 3.8% above its 5-year average and 4.5% above its 10-year average. Meanwhile, the nominal exchange rate has moved to a fresh all time high, with EURUSD at its highest since 2021 and EURCNH its highest since 2014. 

• Policymakers care about a stronger exchange rate because it weighs on import prices and makes domestic exports relatively less competitive. In the current environment, both channels work in a dovish direction for the ECB – potentially increasing the risk of inflation undershooting the 2% target and dragging on already weak economic activity. This may justify further monetary easing beyond what is already priced into markets (terminal of ~1.75%).
• There’s been increased focus on exchange rate commentary after ECB VP de Guindos suggested yesterday that a EURUSD rate above 1.20 would be “complicated” (see here and here for some thoughts on how this could impact near-term EUR sentiment).
• ECB’s Kazaks also suggested yesterday that a significantly stronger Euro could tilt the balance towards another cut. Other policymakers have appeared less concerned though, namely Muller and Centeno.
• There is some tension between ECB officials being concerned about the strength of the Euro while simultaneously calling for the region to take advantage of recent dollar weakness and boost the footprint of the single currency in reserve asset portfolios.  Worth recalling comments from Lagarde on May 26: “Increasing the international role of the euro can have positive implications for the euro area. It would allow EU governments and businesses to borrow at a lower cost, helping boost our internal demand at a time when external demand is becoming less certain."
• Ultimately (as noted by de Guindos) it is the speed of ascent rather than the level of the EUR that will be most important to monitor.