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Europe will weaken the euro for the future of the economy

The European Central Bank (ECB) will review monetary policy and raise the inflation targets for the future of the economy and its growth. This will most likely lead to a weakening of the euro, writes CNBC.

The head of the ECB Christine Lagarde spoke about possible changes in policy. She refrained from direct instructions, limiting herself to vague wording. “In the current environment of low inflation, the problems we face are different from those that took place in 2003, and this circumstance should be reflected in our inflation target,” said the head of the ECB.

Since 2003, the inflation target in the euro area has been set at 2 percent, although the regulator has sought to pursue policies in such a way that real indicators of price increases remain slightly lower. Currently, economists express doubts about the justification of this approach, since low inflation is associated with limited GDP growth, which is especially noticeable in the context of the global crisis.

For 11 years, annual inflation in the euro area has not even reached the target, averaging 1.2 percent. From 1999 to 2008, it stayed at 2.3 percent. At the end of August 2020, monthly inflation turned out to be negative and amounted to minus 0.2 percent after 0.4 percent in July.

The US Federal Reserve System has recently taken similar steps to raise the inflation target, whose head Jerome Powell also speaks of the need to stimulate economic growth by unconventional means.

Regulation of inflation and the total amount of money in the economy is the main task of central banks around the world. Usually, it is achieved by two instruments: changes in the key rate and the required reserves ratio, which banks keep in special accounts with the Central Bank, depending on the number of funds raised.

The higher rate and higher reserve ratio lead to the fact that lending becomes more expensive, and the resources of the banking system, suitable for issuing loans, are reduced. As a result, the amount of money in the economy decreases, the demand for goods and services falls, slowing down inflation. When the rate and reserve ratio is reduced, the opposite processes take place. At the same time, most central banks set a benchmark for inflation, around which they build their policies.

The level of the key rate directly affects not only interest on loans and deposits, but also the yield on bonds, including government bonds, as well as the demand for them from foreign investors. The latter also affects the exchange rate, in the case of the eurozone — the euro. The lower the ECB rate, the less attractive assets denominated in euros become, and the weaker the euro exchange rate.

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