June 1, 2017 / 7:04 AM / 2 months ago

RPT-COLUMN-Buoyant euro comes onto ECB's radar: McGeever

4 Min Read

(Repeats Wednesday's story without changes)

By Jamie McGeever

LONDON, May 31 (Reuters) - Only six months ago the euro was at a 14-year low and on its way to a break below parity with the dollar, so it is remarkable that it's now getting close to levels that could begin to worry some ECB officials.

The European Central Bank will debate the eventual normalisation of policy at its meeting next week, but it's the euro's exchange rate that could figure much more prominently in discussions than was expected up until recently.

$1.15 is the level that could unnerve some policymakers, even though that is comfortably below the euro's launch rate of $1.1741 and a barrier which wasn't breached on the downside between September 2003 and January 2015.

In that light, the current rate of $1.12 can hardly be seen as export-sappingly strong.

Euro zone powerhouse Germany has proved it can withstand - even thrive with - an exchange rate of virtually anything. But some of the so-called peripheral countries exporting lower quality goods aren't so resilient to the euro's upswings.

That's the backdrop to next week's ECB meeting where president Mario Draghi is expected to lower the bank's inflation forecasts and reiterate that the 19-nation bloc still requires extensive stimulus, despite the solid recovery underway.

In some ways, the euro's recent rebound against the dollar is surprising. The Federal Reserve has raised U.S. interest rates twice since December and aims to carry on hiking this year, while the ECB will stick with negative rates and QE bond buying through March 2018.

Yet the euro zone economy grew twice as fast as the United States in Q1 and Citi's economic surprises indices show the U.S. index deep in negative territory, lagging the euro zone's positive surprises by the most in two years.

Oxford Economics go as far to say that "stratospheric" survey data suggests the euro zone may be on the verge of a "golden decade". This level of optimism has given the euro the springboard for a rally of almost 6 percent in as many weeks.

Long, Long, Long

Currency traders have also latched on. The latest positioning data on Chicago futures markets show that FX speculators hold their biggest bets on the euro appreciating since October 2013.

And the rate at which these positions have been built this month has been rapid - May is firmly on track to mark the second biggest monthly rise in net 'long' positions since the euro's inception in 1999.

The euro's rise may have caught the ECB offguard. Staff projections in March and December were for an average exchange rate of $1.07 over 2017-19. A week ago the euro was almost 10 cents above the 14-year low of $1.0340 struck on Jan. 3.

It's cooled a bit since. Draghi tempered hopes of any policy normalisation signals next week when he told the European Parliament on Monday that the euro zone still needs "fairly substantial" monetary stimulus.

The ECB staff projections on oil are also looking stale. In March they projected oil averageing $56.40 in 2017 and $56.50 in 2018, implying a rise of 14.3 percent in 2017 and 7.3 percent in 2018, respectively, from the December 2016 outlook. Non-energy commodities were also meant to rise "substantially" this year.

But oil is down nearly 10 percent in the last six weeks, and euro zone inflation fell to 1.4 percent in May from 1.9 percent in April.

Throw the two together - a stronger euro and weaker oil price than anticipated - and it is much harder for the ECB to achieve its medium-term inflation target of "below, but close to" 2 percent.

That's why the euro may loom large next week. Forward markets are pointing to $1.16 next year and $1.18 the year after, both well above the ECB's $1.07 forecasts.

So Draghi can't be too hawkish, despite the growing clamour from within certain quarters of the bank, or the euro could take off again.

Editing by Toby Chopra

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