European Central Bank President Mario Draghi pledged Thursday to keep a close eye on the recent rise of the euro, which some of the region's leaders worry has the potential to weaken the region's economy further.
Draghi, who spoke after the ECB's monthly policy meeting, said the recent appreciation of the euro was a sign of rising confidence in the region's finances, though he hinted the ECB was prepared to respond if there was a material impact on the economy. The ECB kept its main interest rate unchanged at a record low of 0.75 percent, which is intended to stimulate growth by encouraging businesses and consumers to borrow and spend.
Draghi's comments about the euro surprised markets and helped drive down Europe's single currency from $1.355 to a two-week low of $1.34. The euro has been steadily appreciating since July 25 last year, when it stood at $1.21 amid concerns that the currency would break up.
A rising exchange rate could have a negative impact on the eurozone economy, which is already in recession. It could be bad for automakers, aircraft manufacturers and other businesses that depend on exports for growth. Several European leaders, notably French President Francois Hollande, have highlighted this as a potential problem.
"The exchange rate is not a policy target but it is important for growth and price stability," Draghi said in response to a reporter's question.
"We will closely monitor money market developments."
Analysts were impressed by Draghi's ability to send a clear message to markets.
"Draghi's biggest challenge was to show his magic skills of verbal interventions and to talk down the euro exchange rate," said Carsten Brzeski, senior economist at ING. "He succeeded."
While the euro has risen because of the region's easing financial crisis, analysts also point to actions by other central banks around the world as having an effect. The new government in Japan has indirectly pushed up the value of the single European currency in relation to the yen and other currencies by following a more aggressive economic policy.
The yen has fallen sharply in response to Japan's Prime Minister Shinzo Abe insisting that the country's central bank target a higher rate of inflation.
Bundesbank President Jens Wiedmann warned last month about the impact of the shift in Japan's policy on the foreign exchange markets.
"Until now, the international monetary system got through the crisis without competitive devaluations and I hope very much it stays that way," he said.
The idea of a currency war raises the specter of the 1930s when countries around the world pursued tit-for-tat policies with their exchange rates in order to get an edge. However, the outcome was to decimate global trade, accentuate the depression and sow the seeds for World War II.
The fall in the value of the euro following Draghi's remarks will likely be greeted by France's Hollande, who on Tuesday suggested that the ECB use its powers to bring the value of the euro down.
"A monetary zone must have an exchange rate policy," he said at the European Parliament. If not, it will be subjected to an exchange rate that does not reflect the real state of the economy."
As well as increasing the cost of exports, a rising euro also has the effect of lowering the price of imports — which in turn would affect prices. The ECB's main mandate is to maintain price stability in the eurozone. The current rate of inflation in the eurozone is 2 percent — the ECB's target rate.
Draghi's carefully formulated comments Thursday about the euro, and their effect on the markets, echo his speech to business leaders in London last July. Then the ECB president was credited with easing Europe's debt crisis with his surprise pledge that the central bank would do "whatever it takes" to save the euro.
ING's Brseski said that because Draghi has said that a stronger euro could cause prices to drop, he has "opened the door for new policy action." If the ECB was seriously concerned about a sharp drop in prices, the likely policy response would be to reduce interest rates to try to boost consumption.
Draghi's remarks on the euro came after a cautiously upbeat assessment of the prospects of the eurozone economy. He said economic growth would likely resume in the second half of 2013 thanks to an "accommodative" monetary policy, an improvement in financial market conditions and a pick-up in global demand.
Still, Draghi said risks to growth are "to the downside."
Pylas contributed from London.