FX International Payments
By Frances Coppola
Theory says that the end of QE should mean a higher euro foreign currency exchange rate, which would make Eurozone exports more expensive and imports less expensive in euro terms. However, the euro’s foreign currency exchange rate versus the U.S. dollar dropped on the news that QE would end.2 Analysts thought this was due to accompanying forward guidance that interest rates would remain at their present levels through the summer of 2019, which was longer than many investors had expected.3
But it could also be due to the fact that the Fed’s rate rises and balance sheet reduction tend to strengthen the dollar’s exchange rate. If the ECB keeps interest rates low, and the Fed continues with its present pace of monetary tightening, carry trades (borrowing in a currency with low interest rates and lending it where interest rates are high) may prevent the euro rising versus the dollar when QE ends.
Meanwhile, the Eurozone economy is recovering. Economic growth was strong throughout 2017, and the Organization for Economic Cooperation and Development (OECD) forecasts that growth will continue at the slightly lower but still reasonably robust level of 2 percent in 2018-19.4 Unemployment across the entire Eurozone is falling, though still high compared to the U.S., at 8.4 percent in May 2018.5
The Eurozone’s recovery is led by import-export trade. Almost all Eurozone countries have closed their trade deficits, and some are running external surpluses. Consequently, the entire Eurozone is running a substantial trade surplus in both goods and services versus the rest of the world, and particularly versus the U.S. and the U.K.6
A rising euro foreign currency exchange rate could benefit exporters to the Eurozone, as the value of their exports in euro terms falls and makes them more competitive versus Eurozone-produced goods and services. But even if the euro exchange rate doesn’t rise, the strengthening Eurozone economy could offer attractive opportunities to international businesses looking to develop new import-export trade links and set up local subsidiaries.
Ending QE could make successful Northern European states such as Germany even more attractive places to do business. Many in Germany complain that low interest rates have reduced the incomes of Germany’s savers and damaged the profit margins of Germany’s banks and insurance companies, discouraging savers from spending and reducing business investment.7 Although ending QE may not by itself raise interest rates for Germany’s savers, it is nonetheless a signal that higher rates are on the horizon. This could encourage Germany’s population to spend, its banks to lend, and its businesses to invest, all of which would help to encourage import-export trade. A rising euro exchange rate would also help to encourage imports, potentially reducing Germany’s politically sensitive trade surplus.
Still, the recovery in some Southern European states is remains fragile. In Italy, growth is still poor, and in Spain and Greece unemployment is high at 15.8 percent and 20.1 percent respectively, though it is gradually falling.8 A rising euro foreign currency exchange rate could hamper these countries’ export trade, reducing their incomes and depressing economic growth.
Even if the euro’s exchange rate doesn’t rise, higher interest rates for businesses could dampen investment and inhibit employment in these countries’ crucial export sectors. In this world of global supply chains, it’s worth remembering that exports often have a large import component – so when exports fall, so too can imports. For international businesses, therefore, ending QE could mean that import-export trade with some countries becomes more difficult.
There is an additional problem for countries that are highly indebted, such as Portugal, Italy, and Spain. The ECB’s QE has kept borrowing costs low for those countries’ governments, helping to reduce the extent of fiscal austerity needed to reduce their indebtedness. When QE ends, the yields on their bonds may rise, which could force their governments to impose further spending cuts and tax rises. This would dampen domestic demand in those countries, potentially making it more difficult for international businesses to sell to them.
For Greece, the potential impact of the end of QE is perhaps less evident. Greece is not included in the ECB’s QE program, because its credit ratings are still too low for its sovereign bonds to be eligible for ECB asset purchases.9 There is thus little direct risk to Greece’s fiscal position from the ending of QE.
However, research by the ECB shows that QE has helped to reduce unemployment and raise growth in Greece. Greece is perhaps the most fragile of all the Eurozone countries: if import-export trade fell due to a rising euro foreign exchange rate or higher interest rates for business, ending QE could depress growth in Greece even if it does not in the rest of the Eurozone.
The ECB’s monetary stimulus has brought the Eurozone out of deflation. Now that QE is coming to an end, there are both opportunities and risks for international businesses. Stronger growth and higher domestic demand in some Eurozone countries may encourage businesses to develop import-export trade links and set up new subsidiaries. In others, however, the ending of QE could mean falling import-export trade, either due to a rising euro exchange rate or because of higher borrowing costs for businesses and governments. To mitigate these risks, the ECB has promised to keep interest rates low for a long time to come. It remains to be seen if this will be enough to keep the Eurozone an attractive place for international businesses.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “Monetary Policy Decision June 2018,” European Central Bank; https://www.ecb.europa.eu/press/pr/date/2018/html/ecb.mp180614.en.html
2. “EURUSD,” Bloomberg; https://www.bloomberg.com/quote/EURUSD:CUR
3. “Euro Left Damaged After ECB Quashes Hopes Of June 2019 Rate Rise,” Pound Sterling Live; https://www.poundsterlinglive.com/eurusd/9268-euro-to-dollar-rate-european-central-bank-monetary-policy-in-focus
4. “Euro area forecast,” Organization for Economic Cooperation and Development; http://www.oecd.org/eco/outlook/economic-forecast-summary-euro-area-oecd-economic-outlook.pdf
5. “Unemployment statistics,” Eurostat; http://ec.europa.eu/eurostat/statistics-explained/index.php/Unemployment_statistics
6. “Balance of Payments Statistics,” Eurostat; ec.europa.eu/eurostat/statistics-explained/index.php/Balance_of_payment_statistics
7. “German financial watchdog warns on low rates ‘poison’,” Financial Times; https://www.ft.com/content/2304a2f6-16a5-11e6-b197-a4af20d5575e
8. “Unemployment statistics,” Eurostat; http://ec.europa.eu/eurostat/statistics-explained/index.php/Unemployment_statistics
9. “Greece credit ratings,” Countryeconomy.com; https://countryeconomy.com/ratings/greece