Currency Management

Currency Report - June 2014

It was not just in Britain that the European elections were expected to bring out the not-me voters in force. Fringe parties across the EU were forecast to benefit from electorates' disenchantment with the mainstream establishment. In Croatia it was no different, even though it was the second EU ballot in just over a year; Croatians got their first bite of the cherry just before the country acceded to membership last year. The manifestos of this year's candidates ranged from pro-European to ultra-nationalist to none-of the-above. But Croatians, a bit like Britons, are less than convinced by Brussels politics. Three months ago an opinion poll found that only two fifths of voters knew there would be an election in May and in last year's ballot only half that proportion bothered to cast their vote.

Turnout will have been higher in the core EU countries of France and Germany, perhaps because in those countries the impact of a centralised European Central Bank is more obvious. Croatia, for the moment, is inside the EU but outside the euro zone's single currency. That is not to say Croatia is outside the influence of the ECB. The Croatian National Bank pitches its policy so as to keep the kuna roughly steady against - though not rigidly pegged to - the euro. In a press release issued in mid-May it claimed to have been "again successful last year" because "price stability was maintained and so was the stability of the exchange rate".

In the last month that stability has allowed the kuna the strengthen by just 0.6% against the euro and compared with its level at the beginning of the year the euro/kuna exchange rate is unchanged. So the kuna has gone down against sterling because the euro is under pressure. Since new year's day the pound has strengthened by 2.4% against the euro and the kuna and its gain in the last month was 1.4%.

That is because Britain's economy is performing a whole lot better than that of Euroland and because, for the last six months, ECB monetary policy has been something of a slow-motion car crash. Since the ECB halved its benchmark interest rate to 0.25% in November, in response to a worryingly low 0.5% inflation rate, it has done nothing and inflation is still no higher than 0.7%. The story from the bank's president, Mario Draghi, was that low inflation was a temporary, trifling matter which did not require the central bank's attention.

In early May that attitude of benevolent neglect changed. It is likely to change even more when the ECB Governing Council meets to discuss policy on 5 June. Sig Draghi gave warning at the beginning of this month that "the Governing Council is comfortable with acting [to stimulate inflation and the economy] next time". What form that action may take is up for grabs. It could be a negative deposit rate, meaning that instead of paying euro zone banks interest on their cash the ECB would charge them a fee to look after it. It could be bond purchases, as practiced by the central banks in America, Japan and Britain, to force cash into the system. It could be something entirely novel and unforeseen. But the general assumption is that it will be something.

It is also assumed that it will not be good for the euro. Although the ECB and the national central banks claim not to have a target for the value of the euro there can be no doubt that they would all prefer to see it lower. It is therefore likely that any ECB action would tend to make the euro, and thus the kuna, weaker. All should become clearer on Thursday 5 June.

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