Euro (central bank) politics kill the euro rally--dead

08/27/2010 2:29 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

If this is what a euro hawk is saying now, the European Central Bank will be in the emergency lending business well into 2011. That would match the U.S. Federal Reserve’s recent promise (most recently from Fed chairman Ben Bernanke today, August 27) to continue its policy of depressing long-term interest rates by buying Treasuries and mortgage-backed securities in the open market if the economy needs a boost.

The comments came on August 20 from Axel Weber, the head of the Bundesbank, Germany’s notoriously conservative No-inflation-at-any-cost central bank. Weber, a member of the European Central Bank’s governing council, said the ECB should help banks through the end of the year by continuing its current emergency lending policy.

I’d guess that might be the end of any chance for a euro rally against the U.S. dollar or yen in the rest of 2010. One reason the currency had climbed until recently was speculation that the European Central Bank would start to rein in the euro money supply before the U.S. Federal Reserve did. (And that, while still a long way off, the ECB would raise short-term interest rates before the Fed did in the United States.)

“It’s clear that we need to re-embark on a normalization procedure,” Weber said in tossing a bone to the inflation hawks, but any normalization will have to wait for consideration in the first quarter of 2011. The euro dropped and the yield on Germany’s 30-year bond fell to a record low on his comments.

Weber is one of the leading candidates to succeed European Central Bank president Jean-Claude Trichet in 2011. Opponents to his selection have argued that he’s too much in the mold of a Bundesbank inflation fighter and isn’t a good choice to guide euro monetary policy at a time when growth and jobs are the big issues. I read Weber’s comments as an effort to signal any wavering voters that he will be sufficiently flexible.

Weber’s suggestion to keep the emergency loans to the Euro Zone’s national and regional banks goes far beyond Trichet’s recent commitment to keep the ECB’s unlimited three-month loans in place until the end of September and to keep seven-day loans in place until October 12.

Weber also noted that the European Central Bank is likely to raise its Euro Zone growth forecast next month.

The Bundesbank lifted its German growth forecast for 2010 to 3% from 1.9% on August 19. In June the European Central Bank predicted Euro Zone economic growth of 1% in 2010 and 1.2% in 2011.

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