Going it alone is never easy as the European Central Bank (ECB) found to its cost yesterday. It stepped into the markets to once again support the euro but without the weight of the other major international central banks, its move had little impact.
Its decision took the markets by surprise - only the day before at the ECB's monthly meeting, its president Mr Wim Duisenberg refused to be drawn on whether it would intervene again. The combination of that stance and yesterday's buying, has undone some of the harm caused by Mr Duisenberg's speculation in public, just a few weeks ago, that the bank would not intervene again. The last round of intervention on September 22nd was successful, largely because the ECB along with the US Federal Reserve, the Bank of Japan and the Bank of England acted in a concerted manner. The general rule for intervention to be successful is that it needs to be reinforcing a trend, rather than bucking it. It is also better if the action is concerted among key players rather than unilateral.
The euro had been rallying for several days, hence the ECB met the first criteria. Initially at least, it seemed to be enough and the euro rallied by two cents. However, the ECB's credibility is not yet strong enough with the markets and statements from the other central banks that they were not involved in the intervention, quickly led to selling. By mid-afternoon, the ECB found itself having to step into the markets once again. That round of intervention helped and it is now hoped it will be enough to hold the currency around the $0.86 level.
The most optimistic outlook is that the currency is set to appreciate gradually and that the worst is now behind it. But there is no guarantee of this and investors will continue to test the commitment of the central bank. Further volatility on the currency markets may lie ahead. In its comment, the ECB said it did not ask the other central banks to act with it. This suggests that it did not expect the others to agree to help. It may be that the US administration feels reluctant to act just a few days ahead of the US Presidential election. But US treasury secretary, Mr Larry Summers, sent out a mixed signal yesterday, reaffirming his commitment to a strong US dollar but saying he remained concerned about the weak euro's impact on the global economy.
Longer-term trends remain central to the outlook for the currency. The euro had been weak mainly because investment has been flowing into the US equity market and the US economy. However, economic data published this week has bolstered the view that the US economy may be slowing down and interest rate reductions there are even possible in the New Year. In contrast, the ECB decision to intervene is consistent with the view that a near-term interest rate rise in Europe is likely - the last time, the ECB supported its intervention with a rate increase very shortly after. If this combination leads to a gentle but sustained recovery in the euro's value, then the outlook for inflation here will improve significantly.