As we explained recently, one reason that central banks want to see low, positive levels of inflation is that it would facilitate the normalisation of interest rates which, perversely, are the big weapon in a central bank’s armoury against high inflation. Classically, when interest rates are raised, inflation is reduced, so increasing rates when inflation is close to zero may trigger deflation.
The Eurozone is still struggling with high unemployment and lacklustre economic growth and therefore any rate increase is a long way off since it would tend to stifle business expansion by making the cost of borrowing more expensive (however, this may be so marginal as to make little difference in the current circumstances as borrowing costs are at historic low values). As a consequence, most observers believe that the ECB will announce enhanced stimulus measures at its December meeting which will be aimed at boosting the Eurozone economy by the injection of additional liquidity and stimulating inflation. Given this scenario, many Forex investors are bearish against the Euro and it has already slipped to a 7 month low against the US Dollar.
The portents look good for a December rate hike by the Federal Reserve which ought to push up the Dollar against other major currencies. Most pundits believe that the Bank of England will tighten its monetary policy in the first quarter of 2016, having deferred a rate rise in 2015. These factors will help European exports to be more competitive in importing markets through a cheaper Euro. This could provide an impetus to Eurozone growth, but that is likely to remain very patchy for some time to come, with a broadly north/south schism.
The weaker Euro has already made French wheat exports cheaper than Black Sea region wheat. This could deliver a much needed fillip to French farmers who have seen wheat exports falling by 29% from last year’s levels. However, global demand has been fairly weak despite the fact that cereal crops form a large part of the staple diet across wide parts of the world.