European Central Bank officials signalled heightened concern on Wednesday about the euro’s swift appreciation against the U.S. dollar and the potential consequences for price dynamics. Policymakers warned that a stronger euro could sap inflationary momentum at a time when inflation is already projected to fall short of the ECB’s 2% target.
The dollar fell sharply this week, on track for its largest weekly decline since last April, and briefly hit 1.20 against the euro overnight - its weakest level since 2021. Officials tied the dollar’s slide to market unease over U.S. policy and a move toward safe-haven assets such as gold.
Monitoring the exchange-rate move
French central bank governor Francois Villeroy de Galhau said policymakers were "closely monitoring this appreciation of the euro and its possible implications for lower inflation," calling the currency’s trajectory a key consideration for monetary policy "in the months ahead." He added that the dollar’s weakness versus the euro reflected diminished confidence amid what he described as unpredictable U.S. economic policy.
While the ECB does not target the exchange rate, governors noted that the currency’s strength affects interest-rate deliberations because many important imports - including energy - are priced in dollars, and a firmer euro reduces those costs.
Thresholds and potential policy responses
ECB Vice President Luis de Guindos has previously indicated that an exchange rate around 1.20 versus the dollar was acceptable, though levels above that threshold could complicate the policy outlook. Austrian central bank chief Martin Kocher warned that continued euro appreciation could compel the ECB to reassess its stance, saying further gains could "create of course a certain necessity to react in terms of monetary policy." He made that comment in an interview with the Financial Times.
Markets and expectations
Longer-term inflation expectations have been little changed this week. Financial markets currently anticipate interest rates will remain unchanged over the year, though there is an emerging one-in-four probability of a cut by the autumn. Policymakers have recently maintained that current policy settings align with the economic outlook and that there is unlikely to be an imminent debate over rate changes.
This exchange-rate development is being watched closely by central bankers because of its direct effect on import costs and the potential to pull measured inflation further below the ECB’s 2% target, which could alter the timing or scope of future policy moves.