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Euro area strength and the future of QE

by Danae Kyriakopoulou in London

Fri 1 Sep 2017

Euro area strength and the future of QE Enlarge Chart loading Image

Mario Draghi, president of the European Central Bank, used his time at the Jackson Hole economic policy symposium to defend the importance of countries' openness to trade, threatened by a drift towards economic protectionism.

This is in contrast with the last time Draghi attended the Jackson Hole meeting in August 2014. His remarks then hinted towards easing monetary policy, with the ECB's asset purchase (quantitative easing) programme officially announced a few months later in January 2015 and launched in March of that year. The programme has played an important role in supporting economic recovery in the euro area. GDP across the currency union grew by 2.2% year-on-year according to the latest data for the second quarter of 2017, double the pace recorded in the same quarter of 2014. Unemployment across the euro area stood at 9.1% in June, down from 11.5% in August 2014. Inflation, while still below the ECB's target of close to 2%, is 1.5% and the threat of deflation has receded.

The transmission of QE and its impact on the real economy and inflation occurred mainly through the exchange rate channel, as the ECB's credible commitment to accommodative policy pushed down bond yields and led to the depreciation of the euro. This, in turn, supported exports and brought about a rise in imported inflation.

But these exchange rate benefits are quickly fading. Over 2017 so far, the euro's appreciation in trade-weighted terms is almost 9%, the strongest eight-month rise since the currency's introduction in 1999. On Tuesday the euro-dollar rate rose above $1.20, the highest level since QE began in March 2015. This is partly a correction from a relatively long period of euro weakness and dollar strength – in level terms, the euro-dollar rate is still far below its historical highs – suggesting the euro still has some way to progress.

Danae Kyriakopoulou is Chief Economist and Head of Research at OMFIF.