Beware of the strengthening euro! The European Central Bank may face the risk of long-term inflation falling below 2%
European Central Bank Governing Council member Francois Villeroy de Galhau warned that a significant appreciation of the euro could prevent the central bank from achieving its 2% inflation target. He pointed out that a sustained 10% appreciation of the exchange rate would lower inflation by 0.2 percentage points each year, increasing the risk of missing the inflation target. Although the euro has risen about 14% since January, Villeroy emphasized that the central bank would not set policy for a specific exchange rate, but acknowledged that appreciation has a significant impact on inflation and stated that the possibility of interest rate cuts still exists
According to the Zhitong Finance APP, François Villeroy de Galhau, the Governor of the Bank of France and a member of the European Central Bank's Governing Council, stated that after a significant appreciation of the exchange rate, the European Central Bank is more likely to fail to achieve its inflation target.
In an interview, Villeroy said that policymakers cannot take a "benign neglect" approach to such a significant appreciation of the exchange rate since the beginning of this year.
Estimates cited by Villeroy indicate that a sustained 10% appreciation of the exchange rate would lower inflation by 0.2 percentage points each year over the next three years. He said, "This could increase the risk that we will not achieve our inflation target," adding, "This is a risk we must consider."
Since January, the euro has risen by about 14%, raising concerns among several of Villeroy's colleagues after inflation reached the European Central Bank's 2% target in June.
Earlier this week, European Central Bank Vice President Luis de Guindos stated that an increase in the euro to above $1.20 from its current level of just below $1.18 could make things "more complicated," while the minutes from the ECB's June meeting showed that officials discussed the negative impact of the exchange rate appreciation on exporters.
Villeroy did not comment on Guindos' remarks and reiterated that the European Central Bank would not set policies to achieve a specific exchange rate. He acknowledged that the appreciation of the euro could have a "significant impact" on inflation but also cautioned, "I will not draw any signals from this, nor will I make any decisions regarding the meetings in July or September."
The French official has previously stated that the European Central Bank needs to remain "flexible" after cutting interest rates eight times in a year. He indicated that the path of rate cuts may not be over, and if the ECB takes action again in the next six months, it is more likely to further ease policy.
In the interview, he stated, "We are currently in a favorable position," and "We will wait and see, but this is not limited to the questions of July or September."
He added that given the current "huge uncertainty," policymakers must be "prepared to take a pragmatic and flexible approach based on data" and "act when necessary."
Olli Rehn, a member of the European Central Bank's Governing Council from Finland, expressed concerns earlier this week about inflation being below target for too long. Due to U.S. tariffs undermining confidence, the economy of the 20 countries in the eurozone is struggling to expand, and the European Central Bank expects price increases to remain below target levels for the next 18 months
In France, the inflation rate has been below 2% since last August, dropping to 0.7% in May, the lowest level in over four years.
Currently, the European Central Bank predicts that the inflation rate in the Eurozone will stabilize at 2% by 2027. Villeroy stated that this provides room for policymakers to support the region's economy.
The president stated, "If our inflation target is achieved, we should obviously focus on the growth path, and we can provide support, and we indeed have done so."
He added that the Eurozone's deposit rate level of 2% is "far lower" than that of the UK or the US, "so when people say the European Central Bank is not supporting growth, they should look at the numbers."
