FRANKFURT, Oct 9 - Talk therapy to ease the pain of a rising euro has just begun. The dollar is such a juggernaut that the best thing European policymakers can do to limit damage to their economies from the rising euro is to smooth the path ahead, central bank watchers and currency analysts said. "They cannot do anything to stop it, other than to jawbone a soft landing," said David Brown, chief economist at Bear Stearns in London. In the past two days European Central Bank policymakers have begun gentle verbal intervention to slow the euro, which has gained more than four percent against the dollar since the Group of Seven nations called for flexible currencies last month. ECB Council members have stressed that the leading industrial nations were not seeking a cheaper dollar when they issued their statement at a meeting in Dubai. Rather, Bundesbank President Ernst Welteke told , the G7 wanted to put the focus on to Asia's role in global imbalances. Luxembourg central bank governor Yves Mersch agreed with this interpretation.
This is a welcome switch of tone, analysts said, after ECB President Wim Duisenberg earlier this week fuelled the dollar's decline when he called it "unavoidable". "It is not what they say, it is when they say it," said Stephen Jen, currency analyst at Morgan Stanley in London. Duisenberg was citing basic economics by saying the dollar has to decline eventually to offset the huge U.S. trade gap. But by calling it unavoidable, he gave a green light to markets that saw it as a signal that central banks will do nothing to brake the dollar's fall. Foreign exchange intervention is an option that central bankers should never rule out, analysts said, even when it is highly unlikely from the ECB at the moment. Now ECB policymakers are starting to repair the damage with the first item in a central banker's currency toolbox -- verbal intervention, said Jen.
MONETARY WEAPON
The ECB has other tools ready, should it need them. "I am not sure that they have a huge amount of power to affect this, so the ECB response won't necessarily be to stop the euro rise but to accommodate it," said Ian Stewart, chief economist at Merrill Lynch in London. Easier monetary policy is one such tool, he said. With official ECB interest rates at 2.00 percent, there is room left for another rate cut, possibly as early as December but more likely next year, analysts said. But the ECB is likely to wait and see whether the euro's strength is lasting and to assess its impact. "Above 1.25 against the dollar, the pressure really comes on the ECB from a combination of sub-par trend growth and large falls in inflation early next year," said Stewart.
The ECB's big weapon, though, is currency intervention. It is a last resort and one the ECB has never used without first acting jointly with the U.S. Federal Reserve and the Bank of Japan. It is likely to intervene only if financial markets look in disarray -- such as if there were a sharp spike in Treasury yields, a collapse in Japanese share prices, pressure on European stocks, and the dollar/yen exchange rate goes below 100 -- plus the dollar rout is losing steam, analysts said.
HOW ECB INTERVENES
The ECB, unlike the Fed, has the power to step into foreign exchange markets without government approval, especially if currency turmoil threatens its mandate of price stability. In practice, it does discuss the broader parameters of foreign exchange with euro zone finance ministers at bimonthly meetings. The ECB has a war chest of 174.7 billion euros in foreign exchange reserves, according to July data. Of that, 33.4 billion is at its immediate disposal with the balance held by the national central banks, but the ECB can instruct them to transfer those assets to the ECB in exchange for an interest-bearing note. The ECB can buy or sell currencies itself, pass orders through the national central banks, and send orders through the Fed, Bank of Japan or other central banks where it holds accounts. The ECB last stepped into the currency markets three years ago to halt the euro's tumble below 85 cents to the dollar. It bought euros, first jointly with the U.S. and Japan on September 22, 2000, and then in three waves alone in November. The ECB poured billions into the effort. While it does not reveal exact amounts, its own foreign exchange reserves fell by 9.5 billion euros between August and December 2000. It worked, setting a floor at 82 cents and starting the euro on its 40 percent plus upward climb to $1.1840 today. Longer term, the answer to dollar weakness and euro strength is creating more balanced global growth -- a point ECB Executive Board Member Otmar Issing made on Monday. The problem for the ECB is how to get there without a dangerous dollar crash.//