Eurozone: Will EUR strength weigh on GDP growth? - Wells Fargo

According to analysts from Wells Fargo, we are still a long way away from worrying about the growth-restraining and CPI depressing effects of euro appreciation, because the effects that the exchange rate has on export growth and CPI inflation tends to be rather modest.

Key Quotes: 

“After trending lower between 2010 and 2015, the trade-weighted value of the euro reversed course in 2016 and has risen noticeably this year. Furthermore, our currency strategy team looks for further modest gains in the euro vis-à-vis the U.S. dollar and many other major currencies going forward. In theory, euro appreciation could weigh on real GDP growth in the Eurozone if it leads to slower growth in real exports of goods and services in the euro area. It could also depress consumer price inflation even further if it causes import prices to level out and potentially decline.”

“We are still a long way away from worrying about the growth-restraining and CPI depressing effects of euro appreciation. For starters, the common currency that is shared by the 19 member countries of the euro area means that there is a significant amount of trade in the Eurozone that is not affected by exchange rate changes. Moreover, the effects that the exchange rate has on export growth and CPI inflation tend to be rather modest. Yes, real appreciation in the euro exchange rate is associated with slower export growth in the Eurozone, everything else equal.”

“But the effects of economic growth in the rest of the world are significantly more important for real export growth than is the real exchange rate. As long as the global economy continues to expand at a healthy pace, which we expect, then real export growth in the euro area likely will remain positive.”

“Similarly, the effects of the exchange rate on CPI inflation tend to be rather small as well.”

“Euro appreciation could eventually shave off a few tenths of a percentage point off of CPI inflation in the Eurozone. However, as long as the economic expansion in the euro area remains healthy, which we expect, inflation should slowly trend higher over time. Consequently, we look for the ECB to dial back its bond purchases further in coming months and for it to commence a slow pace of rate hikes in late 2018.”