FRANKFURT (MNI) – The European Central Bank is keeping a close eye
on the euro and its potential for further appreciation as it ponders the
pace of its exit from very accommodative policy.

Governing Council member Ewald Nowotny said Friday that while the
euro is “relatively high,” this is no cause for alarm, at least in the
short term.

However, if the common currency stays high “over the long term, it
does dampen our exports,” he commented.

Nowotny underlined that policy cannot stay as loose as it is
forever, reinforcing comments in recent weeks by more hawkish members of
the Council, such as Juergen Stark and Axel Weber.

The ECB’s current low refinancing rate of 1% is the result of the
financial crisis and “it won’t last forever,” Nowotny said.

The ECB “certainly won’t be able to raise it immediately, but it is
certainly not a long-term rate,” he added. “Long term, we must assume
that there is a tendency towards an increase.”

The question is, When? Nowotny said there is no danger of inflation
in the Eurozone, which implies little urgency to tighten soon.

The divergent paths of the world’s other central banks will likely
make the ECB stop and reflect about its next move to tighten. If the
Bank of England renews asset purchases — a close call — and the Fed
follows suit — considered more likely — the euro could continue
higher, even if the market appears to have largely priced in a new round
of quantitative easing.

Hawks at the ECB want to tighten sooner rather than later. Weber is
pushing for an end to purchases of government bonds. Stark underscored
Wednesday the need to “constantly examine how appropriate and necessary”
the bond-buying program still is. He noted that last week the central
bank did not buy any new bonds, perhaps hinting that the finish line is
not that far away.

Recent indicators confirm the contrasting pace of economic recovery
within the Eurozone, especially the resilience of Germany’s upswing.
October’s flash PMIs and Ifo’s latest barometer of business sentiment
both surprised to the upside this week. Most surprising was the rebound
in Ifo’s expectations index, which few analysts had expected.

German firms across all sectors appear to expect the momentum of
domestic demand to compensate for any slowdown in global growth.

The same cannot be said for Europe’s periphery, where the slightest
hint of bad news still triggers bond market tensions reminiscent of the
sovereign debt crisis this spring.

Earlier in the week media reported that Ireland might need to cut
next year’s budget by E5 billion more than originally anticipated.
Portuguese sovereign bonds also came under pressure the week after
reports that the government would delay a vote on its budget. Spain’s
unemployment is still alarmingly high at over 20%.

The consequences for monetary policy are clear: subdued
inflationary pressures allow time for a gradual exit, whereas premature
tightening might exacerbate diverging economic trends.

Executive Board member Lorenzo Bini Smaghi reiterated Friday that
the ECB has no definitive timetable for the unwinding its liquidity
supports. “We will decide based on the situation,” he said.

While the recent rise in short-term interest rates suggests that
markets are anticipating a further unwinding of liquidity measures,
there is little reason to expect the ECB to announce any move before
December.

–Frankfurt newsroom +49 69 72 01 42; Email: tbuell@marketnews.com

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