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Currency Management

Currency Report - May 2014

The village of Smilja in the Lika region has a population of just 400. It also has a museum, a memorial to a man born there who had such an impact on late-19th-century electrical engineering that the SI unit of magnetic flux density is named after him. Today the name of Tesla is more commonly associated with electric cars and that is why the Nikola Tesla EV [electric vehicle] Rally will pass through Smilja at the end of next month.

If the rally is a financial success its contribution will not come amiss to Croatian gross domestic product, which has expanded in only six of the last sixty months. Since the onset of the global financial crisis Croatia's economy has struggled unsuccessfully to get back onto an even keel and it looks as though that struggle must continue. Finance Minister Slavko Linic said in mid-April that the government's earlier projection of 0.2% economic growth for 2014 had been canned: Now the forecast is for zero growth.

But the news has not had any adverse impact on the kuna. In fact during the last month the kuna has strengthened slightly against the euro. At its current level around 7.62 the euro/kuna exchange rate is not materially adrift from its position a year ago. However, the kuna remains at a disadvantage to the British pound, which has enjoyed both a good year and a good month. Sterling's monthly gain is 1% and over the last twelve months it is up by 3.5%.

Those gains are almost entirely the result of sterling's upward progress against the euro. In the last month it has risen by two euro cents, principally as a result of strong UK economic data but also because of the dangling threat of quantitative easing by the European Central Bank. The pound's biggest boost came from a fall in the rate of UK unemployment to 6.9%. Not only is that far lower than Euroland's 11.9%, it is also below the 7% threshold previously specified by the Bank of England as a prerequisite for higher interest rates. Whilst the BoE abandoned that marker a couple of months ago, preferring to see instead a narrowing of the "productivity gap", UK unemployment has surprised just about everybody with the speed of its drop.

That is not to say the euro zone economy is on the ropes. At least in the private sector things seem to be going well. The purchasing managers' index readings, which measure conditions in the manufacturing and services sectors, suggest that business is picking up across the board. But in the opinion of almost everyone apart from the ECB Governing Council, the threat of inflation poses a danger to the euro zone economy. At the last count consumer prices had risen by just 0.5% in twelve months. Granted, that is more helpful than the -0.4% by which Croatian consumer prices fell over the same period but it is a far cry from the 2.0% inflation rate which the ECB is mandated to maintain.

So investors are waiting (and waiting and waiting and waiting) to see what the ECB will do to rectify the situation. Its president says nothing needs to be done; prices will begin to rise of their own accord. But there remains the suspicion that the ECB cannot indefinitely sit on its hands. So will it be a programme of bond-buying to pump money into the economy? A negative interest rate that will mean commercial banks paying the ECB to take their deposits? Another cut in the ECB's already ultra-low 0.25% refinancing rate? Some other "unconventional measure"?

If inflation does indeed pick up of its own accord there will be a sigh of relief and the euro will find renewed support. But if the ECB decides the time has come to turn words into actions that dangling threat will drop and knock it for six. Or at least four.


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