Forex Flash: Critics claim EU monetary policy caters to core – UBS

FXstreet.com (Barcelona) - It’s important to take a look at how the EUR behaves in response to changes in inflation expectations, especially across different countries. This is often a source of contention as there is often a perception in southern Europe that monetary policy is set according to the needs of the core, while fiscal direction is now being set according to the needs of the periphery. This has been an especially painful process for the periphery at many points in the cycle and endlessly debated within political and policy circles.

According to Research Analysts Gareth Berry and Geoffrey Yu at UBS, “The EUR's performance correlation has changed in break-even rates in France, Germany and Italy, and it's quite clear that these criticisms have some foundation. The premise is that the euro is influenced 1-1 by the ECB, which in turn continues to stick resolutely to its inflation mandate.”

The EUR's performance has enjoyed a consistently positive correlation to the German break-even for the last two years. If the euro reflects the ECB's policy direction, then the ECB is clearly anchoring German inflation expectations and this is still valid during periods of sovereign stress. In contrast, Italian break-even changes have not had a stable relationship to the euro and sometimes it was outright negative. France has been somewhere in between, but now is converging more to the Italian case as more investors are now questioning its 'core' status. However, “If the ECB does not adjust accordingly, political pressure will at some point be unavoidable. We leave this debate for another day, but with the currencies increasingly looking to normalize their response functions to inflation, the euro might yet be the odd one out.” they add.