by Peter Lavelle
Britain's pound sterling has hit its highest versus the euro in almost 7 years today, or since May 7th 2008, at 1.2908.
This is because the President of the European Central Bank Mario Draghi has told German newspaper Handelsblatt that the possibility of deflation in the Eurozone "cannot be entirely excluded."
In a rare newspaper interview, Mr. Draghi, Europe's most powerful central banker, conceded that there's now a risk that the common currency bloc will experience a period of negative inflation, whereby prices continually fall.
Risk of economic stagnation weighs on euro
This lifted sterling versus the euro, first because deflation is widely associated with economic stagnation.
For example, Japan succumbed to deflation in the 1990s, and subsequently failed to grow its economy for years, a period referred to as its "lost decade".
Given this, if the Eurozone falls into deflation, it may also presage the currency bloc's own "lost decade".
Euro may be devalued by quantitative easing
Second, Mr. Draghi's comments also lifted the pound against the euro, because they increase the odds that the European Central Bank will launch emergency monetary stimulus, called quantitative easing, to fend off deflation.
Were the ECB to initiate quantitative easing, it would substantially strengthen the pound against the euro, because it involves injecting billions of euros into the financial system, thereby lifting the rate of inflation, but simultaneously weakening the value of the common currency.
Hence, the pound has hit this near 7-year high versus the euro, in anticipation that the European Central Bank will soon take measures that would bring down the euro.
