ECB and Monetary Policy: A Closer Look

dollToday ECB President Mario Draghi is expected to keep interest rates at a record low 0.75 percent at the ECB meeting despite the euro at 2011 highs and rallying nearly 9 percent since Draghi’s pledge in July to do “whatever it takes” to support the euro.

A resurgent euro is not sitting well with France’s PM  President Francois Hollande who on Tuesday urged the 17 member euro bloc area to set a mid-term target for the Euro’s exchange rate and establish a comprehensive jobs policy.

“A monetary zone must have an exchange rate policy or else it ends up subjected to an exchange rate that does not match the true state of its economy” Hollande said during a speech addressed to the European Parliament in Strasbourg.

A strong euro makes it difficult for European companies to export goods across the global market at a time when growth is sorely needed across the euro-area to help drive down its unemployment rate and create more economic stability.

ECB chief Mario Draghi mentioned in January that the euro’s trade-weighted index has been more stable and is still down more than 10 percent from the highs of 2009.

Today the yen is bouncing off yesterday’s 33-month low against the dollar.

The euro fell against the dollar and a strengthening yen.

The Bank of Japan’s (BOJ’S) plan to assertively weaken the yen and follow loose monetary policy is the primary catalyst behind the yen’s precipitous drop which is intended to boost their exports and prevent deflation.

The Bank of Japan raised its inflation target and pledged limitless stimulus.

On Tuesday BOJ governor Masaaki Shiraka reported that he will step down on March 19th, three weeks before his five-year term ends in April.

In the United States the Federal Reserve’s decision to continue purchasing securities at a rate of $85 billion per month until the unemployment rate falls to 6.5 percent will pump more liquidity into the market even despite concerns of future inflation.

Many economists believe that the United States is still a long way off from obtaining an unemployment level of 6.5 percent, especially with the United States’ unemployment rate moving up to 7.9 percent from 7.8 percent in January and the federal government preparing for across the board sequester cuts scheduled to begin on March 1st unless politicians in Washington are successful in working out a new deal before March 1st to prevent the budget cuts.

On Tuesday the Congressional Budget Office (CBO) said that future sequester cuts would amount to $42 billion less in federal spending between early March and the end of September.

In 2013 sequester cuts are expected to lower the federal budget by $85 billion as a result of  “across the board” federal cuts in defense and non-defense spending.

The concern over artificially low Treasury yields from the Fed’s security buying spree of $ 85 billion per month is that complacency could set in among policy makers in Washington D.C.,  leading to a failure to act with urgency in tackling the U.S. debt problem, believing that loose monetary policy might be the right engine for the United States to expand its GDP growth instead of relying on other unpopular instruments such as comprehensive fiscal reforms.

Congress is currently searching for new ways to delay the sequester budget cuts but there has been little progress made thus far.

On Tuesday President Obama demanded that Congress approve legislation to replace at least some of the $85  billion in automatic spending cuts which are set to begin on March 1st.

Obama said the cuts should be replaced by both spending cuts and tax hikes.

Obama appears to be willing to have Congress approve a smaller package deal rather than face no new package at all.

“If they can’t get a bigger package done by the time the sequester is scheduled  to go into effect, then I believe they should at least pass a smaller package,” Obama said.

Republicans responded by saying that Obama’s plan for new revenues in a short-term deal was a non-starter since he just received $600 billion in tax increases during the “fiscal cliff’ negotiations in December.

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