The European Central Bank (ECB) decided on continuing its bond purchase program also known as quantitative easing till September while keeping interest rates unchanged. The ECB originally kicked off their massive quantitative easing program early 2015 in hopes to stimulate the economy and encourage banks to make more loans. The bank targeted the supply of money by purchasing corporate bonds and putting an end to the scarcity of government bonds. Earlier this month, the ECB President Mario Draghi indicated his efforts to taper quantitative easing starting September 2018.
“Incoming information…confirms the strong and broad-based growth momentum in the euro area economy, which is projected to expand in the near-term at a somewhat faster pace than previously expected.”
The decision to eliminate this so-called “easing bias” will have a major global impact on the economy. In the past few months, the euro has risen against the dollar on the more hawkish movement from the central bank. Although a strong euro could have an impact on the European exports and influence prices in the euro-zone, the efforts to taper quantitative easing has devalued the dollar.
As the U.S. Dollar Index (DXY) gradually weakens, inflationary risk generates and upward momentum in the U.S. economy. In this case, the Federal Reserve uses short term rate hikes to help the U.S. economic structure and aggregate demand. In the most recent job report, employers added 313,000 new jobs in early 2018 without reducing the unemployment rate of 4.1%.
Former Fed advisor Andrew Levin said, “It seems increasingly plausible that the economy is still well short of full employment.”
This further suggests room for a growing economy and a tighter labor market in the United States. Inflationary risk rises when the economy heads towards a tight labor market causing the Fed to increase short-term rates. With the ECB’s plan to normalize its monetary policy and the tightening U.S. labor market, the Fed is set to raise rates three to four times in 2018 to strengthen its currency and the overall economy. The ECB continues to closely examine the exchange rates and economic outlook in the euro-zone.