By Jessica Mortimer and Ana Nicolaci da Costa
LONDON, Oct 1 (Reuters) - A year after the European Central
Bank pledged to do all it could to save the euro, the currency's
new-found strength is tangling with its efforts to keep euro
zone monetary policy loose.
When ECB President Mario Draghi said last week the central
bank stood ready to offer more long-term loans to banks to keep
money-market rates from rising, some in the market saw it as a
covert - and misguided - attempt to talk down the
With the euro near a two-year high on a trade-weighted basis
, traders expect more such talk, but not much
impact on the currency. The euro remains supported by an
improving economy, the ECB's 2012 promise to save it, and the
U.S. Federal Reserve's decision last week to leave its monetary
stimulus programme unchanged.
"The ECB won't welcome either the strength of the euro or
the push higher in market rates. I think they will step up the
rhetoric," said Rabobank senior currency strategist Jane Foley.
"This year is different to previous years. We can talk about
real euro resilience."
The ECB issued unprecedented "forward guidance" to curb a
rise in money market rates in July, saying interest rates would
stay low for a prolonged period.
That policy was unveiled when the prospect of the Fed
slowing the pace of its bond-buying stimulus was pushing
money-market rates higher.
But paradoxically, Draghi's hint at the prospect of more
cheap loans came days after the Fed's surprise decision drove
euro zone money market rates to six-week lows.
That led some analysts to believe he may this time have had
the euro's strength in mind, because the Fed decision pushed the
euro to an eight-month high against the dollar.
"There is a lack of any direct reference by Draghi (to the
euro) ... What you do get is indirect comments the market
interprets as a very veiled, latent concern that the euro can
get too high and too expensive," said Neil Jones, head of hedge
fund FX sales at Mizuho.
The euro rose to $1.3569 after the Fed left its monetary
policy unchanged on Sept. 19. On Tuesday, a political stalemate
that partially shut down the U.S. government pushed it to
A stronger euro is unwelcome to the central bank because it
can hurt exports, potentially threatening the euro zone's
nascent recovery. A strong currency and higher money-market
rates both effectively tighten financial conditions.
"At $1.35 and possibly drifting towards $1.40, the market's
interpretation is this is an amber light on currency concern,"
Draghi is likely to expand on his recent comments at a news
conference on Wednesday after an ECB policy meeting.
A Reuters poll shows economists expect the ECB to conduct
another long-term refinancing operation (LTRO) for banks at the
end of this year or early next.
It made more than a trillion euros in cheap loans available
in late 2011 and early 2012, most of it now repaid.
But any attempt by the ECB to curb a rise in money-market
rates and the euro will be complicated and overshadowed by U.S.
monetary policy, analysts say.
The Fed's decision to delay tapering its stimulus has at the
same time helped and hindered the ECB's attempts to keep euro
zone monetary policy loose, since it pushed money market rates
lower but boosted the euro.
And as soon as investors think tapering is back on the
table, that would push the euro lower, as investors buy dollars,
but would probably cause euro zone money market rates to rise,
even if euro zone policy remained accommodative.
Salman Ahmed, global fixed-income strategist at Lombard
Odier, said using the LTRO as a monetary policy rather than a
crisis-fighting tool was misguided.
"The sensitivity of money markets to these policy measures
starts to fall when rates are this low. The first LTRO had a
huge impact because the rates were very high and it was targeted
towards the banking sector."
Indeed, for the ECB to have maximum effect both on the euro
and on euro zone money markets, some analysts say the ECB should
time its LTRO to coincide with the Fed scaling back its
That way, the LTRO could curb any rise in euro zone money
market rates stemming from the Fed action, which would push the
euro lower as the dollar rose.
"They (the ECB) want to build a perception in the market
that the ECB has something to set against any rise in front-end
rates, especially when tapering speculation should become more
acute going forward into Q4," said Commerzbank strategist