Newsletter article

Currency Report - September 2014

European Coastal Airlines is ready to expand its scheduled seaplane service along the Croatian Adriatic coast. It has taken well over a decade to secure the individual licences, planning consents, harbourmaster permits and coastal business concessions from each of the proposed two dozen destinations.

In 2000, the year the airline began to operate a limited service, the value of the kuna averaged 7.63 per €1. At the time of writing it is once again 7.63. The kuna has not been exactly stationary against the euro over the intervening 14 years but it certainly has not moved far.

The same is not true of the pound against the euro. In 2000 the pound would buy an average of €1.63 and today it gets you just €1.26. That 23% decline explains why the focus for Croatian-oriented Brits must be on the exchange rate between the pound and the euro.

Over the last 12 months the daily average of sterling's value has been €1.2159. The pound has been trending upwards. Its rise is partly because investors are waiting for the Bank of England to take interest rates higher, either late this year or early in 2015. It is also because those same investors believe the European Central Bank is about to embark on the same money-printing, bond-buying, economically-stimulative quantitative easing that the central banks of Britain, America and Japan have already put into practice.

This might sound like a long-running story but, sadly, it is. Almost a year ago it was clear that the euro zone economy was not recovering at the same pace as those of Britain and the United States. As the same time it became evident that inflation in Euroland was slowing more than it should. In the year to September 2013 consumer prices in the euro area went up by 0.5% and inflation since then has been consistently less than half the 2% which the ECB is supposed to maintain.

The ECB has pondered and postured, arguing that the current ultra-low inflation is nothing to worry about. It has cut its benchmark interest rates, such that when commercial banks give it money on deposit they do not receive interest, they have to pay interest of 0.1% for the privilege. ECB President Mario Draghi has said that the bank has additional weapons in its armoury, implying that quantitative easing (QE) is a possibility if there is a worrying decline in inflation expectations. But Germany, the ECB's paymistress, is vehemently opposed to QE, so the additional weapons in the ECB armoury have so far remained unused.

That might be about to change.

In a speech to other central bankers at the end of last week Sig. Draghi conceded that inflation expectations have indeed become unanchored in the euro zone. Whilst he did not - could not without the support of the ECB Governing Council - say a QE programme was about to be unleashed, he did imply that he was leaning in that direction.

This coming Friday brings the provisional reading for euro zone inflation in the year to August. The most optimistic survey of economists puts the consensus forecast at 0.3%. At that level or lower it is hard to see how the ECB can continue to sit on the sidelines. Barring miracles, Euroland QE is on the cards and it will almost certainly mean a lower euro.

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