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 Euro zone central bankers have spelled out the need for a weaker
euro to breathe life into the bloc's economy, which flatlined in the
second quarter and is flirting with deflation.
Such comments are usually a no-go among the big industrialized
nations for fear that one country's bid to become more competitive
might trigger a race to devalue currencies and prompt other
economies to resort to protectionism.
But ECB measures that have helped push down the euro to below $1.30
from just shy of $1.40 in May have drawn little objection. These
include verbal interventions, cutting interest rates close to zero
and a pledge to flood the banking system with money via cheap loans
and purchases of private sector debt.
"People aren't criticizing the ECB as triggering a currency war,
because they are worried the euro zone may slip into deflation,"
said a Japanese policymaker with direct knowledge of exchange rate
policy. "It's in the interests of the global economy for Europeans
to do what's needed to avoid deflation."
 Japan got a similar pass from its G20 peers last year when Prime
Minister Shinzo Abe launched an aggressive mix of monetary and
fiscal stimulus that pushed the yen sharply lower.
Having urged Tokyo for years to do something to galvanize its
listless economy, other major economic powers could hardly complain
about such "Abenomics".
The problem for the ECB is that its new funding may not pass through
to businesses and households as intended. Many euro zone banks are
still laden with bad loans and struggling to meet regulatory demands
for more capital buffers, while uncertainty from the conflict in
Ukraine and a sanctions war with Russia could spoil companies'
appetite for new loans.
A weaker euro might be a more effective remedy.
"With the euro zone doing worse economically than the United States
and United Kingdom, a weaker euro against the dollar and pound is
just what the doctor ordered," said Barry Eichengreen, professor of
economics at the University of California and one of the world's
foremost experts on currency systems.
"There would then be an end to the litany of financial shocks
originating in Europe that have perturbed U.S. financial markets for
the last four years."
The United States has criticized currency policies in the past -
urging China, for example, to move towards a market-determined
exchange rate - but its bigger concern now is possible deflation in
Europe.
"Some recent steps and further discussion in Europe toward a more
accommodative pro-growth strategy are encouraging, but boosting
domestic demand is key and efforts to do so should be supported by
decisive actions across a full range of economic policies – fiscal,
structural and monetary," a U.S. Treasury official said on Friday.
RAISED EYEBROWS
Although ECB chief Mario Draghi's initial efforts to talk down the
euro raised eyebrows in Tokyo, policymakers there have been silent
on recent verbal interventions by ECB officials.
After nearly two decades of deflation and economic stagnation - and
with the yen at a six-year low against the dollar helping Japan's
export-reliant economy - they know how important the currency
channel can be.
When the Bank of Japan launched its massive quantitative easing (QE)
program in April last year, a tumbling yen was regarded as a key
transmission mechanism, driving up import costs and salaries at
exporters. That helped push core consumer inflation to above 1
percent from below zero in a year.
"The ECB's stance is similar to what Japan is doing and no-one can
criticize that," Nomura currency strategist Yujiro Goto said. "If
the euro continues to depreciate that might be a bit negative for
Japanese inflation momentum, but at this moment people are more
focused on dollar/yen, which is appreciating again."
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Japan's stronger business ties with Asia and the United States mean
a weaker euro will affect it only marginally, although BoJ Governor
Haruhiko Kuroda has said he is ready to talk down the yen if the
euro fall triggers a yen spike.
Some Japanese policymakers see the ECB's explicit language on the
euro as a sign of desperation, pointing to its depleted policy
arsenal and high threshold for deploying QE.
Worried that stagnant euro zone demand will drag on emerging Asian
economies, they see merits in allowing Europe to take whatever steps
are needed to revive growth, as long as there is no direct
intervention in currency markets to weaken the euro.
RED LINE
When ECB policymakers talk about the euro, they emphasize that the
exchange rate is not a policy target. But the ECB has an inflation
target and the exchange rate influences inflation.
Draghi said in March, for example, that an effective rise in the
euro of about 8 percent since mid-2012 had knocked 40 to 50 basis
points off headline inflation, which was then 0.5 percent but slowed
to 0.3 percent in August.
French central bank governor Christian Noyer said last week the
euro's roughly 4 percent fall since meant policymakers' rhetoric had
"succeeded perfectly", adding: "We needed to bring the euro down and
we still need to bring the euro down."
"The significant point here was to affect the exchange rate," his
Austrian counterpart Ewald Nowotny said hours after this month's
unexpected interest rate cut.
The ECB's latest staff projections see import prices rising, helped
by a weaker euro, which should feed inflation, but the bank stresses
it could do more if deflation risks persist - including broadening
asset purchases to include sovereign bonds.
The currency may be a trigger for that: "All things being equal, a
stronger euro justifies a more accommodating monetary policy,"
Executive Board member Benoit Coeure said last week.
Provided the ECB sticks to domestic assets and does not intervene
directly - neither of which are on its agenda at present - its
central bank peers are likely to tolerate its actions unless the
euro takes a dramatic dive.
"Continuing to take steps to actively push down the exchange rate
after the euro has fallen by, say, 30 percent would be enough to
excite foreign critics," Eichengreen said.
"But the euro's fall to date is only 5 percent on a trade-weighted
basis. So any red line is far off in the future."
(Editing by Catherine Evans)
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