The European Central Bank’s reluctance to raise interest rates to counter spiraling inflation is aggravating misaligned exchange rate problems, intensifying the imbalance in international current account balances.
Widespread perception that the ECB is falling behind the US Federal Reserve and Bank of England on rate hikes, depressing the euro on FX, is likely to further fuel zone inflation euro by increasing import prices. Another side effect is the widening of the US current account deficit, which fuels trade imbalances as a disturbing factor in US politics.
Given that the price of oil and most internationally traded commodities is in dollars, the fall in the euro – to €1.07 from €1.21 a year ago – adds to the pressures inflationary. This is one of the concerns of a minority within the Governing Council of the ECB which is trying to push the bank for a bigger hike in the key ECB rates. These council members, including Joachim Nagel of the Bundesbank and Klaas Knot of De Nederlandsche Bank, want the ECB to raise its deposit rate to 0% from -0.5% in July, which will be deliberated at its meeting on June 9.
It is not known whether they will obtain a majority. Concerns about the effects of Fed tightening, along with the phasing out of the ECB’s government bond buying programs, are pushing credit spreads higher in bond markets across Europe. The spread between 10-year yields on German and Italian bonds is now two percentage points, the highest in two years. Similar trends are underway for Spain, Greece and Portugal, leading to higher borrowing costs for the most indebted eurozone states.
The ECB’s dilemma on monetary tightening adds to global imbalances. The weak euro is boosting eurozone exports – especially from traditionally strong exporters like Germany – and weakening the competitiveness of US businesses, leading to widening trade gaps.
Another important factor was the renminbi’s 6% decline against the dollar over the past month. The decline does not appear to reflect a deliberate move by Beijing to sell more products in the United States, rather the effect of US interest rate policy, China’s Covid-19 shutdowns and Western sanctions against the Russia.
With US imports from China outpacing exports by about four to one, the US recently ran a trade deficit with Beijing of more than $30 billion per month, resulting in an overall Chinese trade deficit of 101 trillion dollars in the first three months of 2022. Former President Donald Trump will likely use the continuing huge imbalance in China-US trade in his likely bid for re-election in 2024.
The overall US trade deficit rose 22% in March, topping $100 billion for the first time – up $20 billion from February to $110 billion, according to the US Census Bureau . April estimates from the International Monetary Fund put the euro zone’s current account surplus this year at 1.8% of gross domestic product, down slightly from 2.4% in 2021, despite the much larger bill. high in imported energy. Proof of the strong underlying competitiveness of the euro zone, the current account surplus for 2023 is estimated at 2.2% of GDP.
Germany’s current account surplus – usually criticized by the United States as signaling excessively high savings and insufficient domestic growth – is expected to fall to 5.9% of GDP in 2022, from 7.4% in 2021. But the surplus will drop to 6.9% next year, according to IMF projections.
Imbalances in the two largest Anglo-Saxon economies remain acute. The US current account deficit is estimated at 3.5% of GDP in 2021 and 2022, narrowing only slightly to 3.2% next year. The UK’s deficit over these three years is estimated at 2.6%, 5.5% and 3.2% of GDP respectively.
China’s current account surplus is projected at a relatively moderate level of 1% of GDP in 2022 and 2023 after 1.8% in 2021. However, these forecasts were prepared before the latest decline in the renminbi which, if prolonged , should lead to a further sharp rise in the Chinese surplus.
Exchange rates often do not match the underlying competitiveness of countries due to differences in interest rates, which can lead to job destruction, disruptive relocation of assets and a surge of populist politicians offering solutions simplistic. Central banks need to take better account of their responsibility in this area with a more coordinated approach – as has been the case with the international minimum standards for the taxation of corporate profits.
Bob Bischof is Vice President of the German-British Chamber of Commerce and Industry. David Marsh is President of the OMFIF.