Mario Draghi said that a 10% rise in the currency knocks around 0.4%-0.5% off of inflation. The RBA says that a temporary 10% rise in its currency would knock 0.3% off of GDP and CPI over a couple of years. So now we are seeing the currency move in Europe’s favour we should start to see the effects reverse yes?
Here’s a chart of the euro alongside GDP and inflation including the last big currency moves in percentage terms.
Eurozone currency vs HICP vs GDP
If we look at the period between June 2010 and June 2012 the euro went up and down around 3000 pips yet growth and inflation didn’t make the moves that the central banks tell us they should. Inflation continued to fall as did growth.
So far the 16% move up in the currency to 1.40 has been more that halved with a 10% fall to date. Bear in mind that CPI and GDP suffer a fair bit of lag from the currency moves so we should start seeing some steadying of inflation, at the very least now or very soon (well not today anyway). We can probably say that 4 months is a good period to see the effects of rate moves and currency moves playing out in CPI and GDP.
Here’s why these studies don’t work. Right now we are in unprecedented territory and coming off the back of a huge shock to every economy in the world. Central banks are taking extraordinary steps to maintain their economies and financial systems and to a certain extent they are all trying to find a balance between them. The US saw a 50% drop in it’s currency against the yen since 1990 and how has that done their growth and inflation?
The rules of currency effects on an economy are all well and good and can be monitored, to the level that central banks are telling us about now, when the economic boat is steady. When things are running smoothly then a 10% changes in the currency can be seen in greater detail, and dealt with better. At the moment its effect is just like a pin drop at a heavy metal concert.
As I’ve said time and time again, Europe and the ECB need to worry about much more than the currency. The proof of the pudding is not what I say though, but what the fundamentals say in the weeks and months ahead. The currency is now down over 10% since the 1.40 highs and is still looking weak. Europe had its currency excuse and now has its currency wish. Let’s see what they do with it.
