Study finds ECB exchange rate communication largely ineffective

A new ECB working paper concludes that the European Central Bank's communication on exchange rates has limited and quickly fading effects. This is particularly evident when interest rates are at their effective lower bound.

Limited impact, quick fade

A new ECB working paper challenges the effectiveness of central bank communication on exchange rates, largely supporting the skeptical view.

The study, based on nearly 100 official ECB statements since 2002, finds that exchange rate communication has limited immediate effects on the euro exchange rate, which fade quickly.

This ineffectiveness is particularly pronounced when interest rates are at their effective lower bound (ELB).

The research highlights that monetary policy shocks, rather than communication, are the dominant drivers of exchange rate movements, explaining approximately 16 percent of high-frequency variations during press conferences.

This finding underscores the need to control for monetary policy shocks when assessing communication impact.

ECB fundamentals, journalist visibility

The paper contrasts two perspectives: a skeptical view, arguing communication has minimal impact, and an optimistic view, suggesting it can influence exchange rates.

The analysis reveals that the ECB tends to mention the exchange rate when the real effective exchange rate deviates from its equilibrium value.

In contrast, journalists' questions during press conferences are primarily responsive to the nominal exchange rate.

This suggests the ECB bases its communication on underlying fundamentals, while media focus on more visible, short-term factors.

Early in the sample, communication showed some effectiveness, but this diminished once interest rates reached the ELB.

Communication's limits exposed

This study provides a crucial reality check for central banks relying on verbal intervention to guide exchange rates.

While communication remains a vital tool, its direct power over currency movements appears significantly overstated, especially in low-rate environments.

Policymakers must therefore prioritize concrete monetary policy actions over rhetoric when aiming to influence exchange rate dynamics.