By Eva Kuehnen
FRANKFURT (Reuters) - The European Central Bank will monitor the impact of a strengthening euro on the currency bloc's economy but said it was not a policy target and showed growing confidence in the region.
After the ECB left its main interest rate at 0.75 percent on Thursday, ECB chief Mario Draghi said the exchange rate was near to its long-term average but went further than many analysts had expected.
"The appreciation is, in a sense, a sign of return of confidence in the euro," Draghi told a news conference.
"The exchange rate is not a policy target, but it is important for growth and price stability and we certainly want to see whether the appreciation is sustained and will alter our risk assessment as far as price stability is concerned."
The euro hit a 15-month peak of $1.3711 on February 1. It traded below that level on Thursday.
French President Francois Hollande said on Tuesday the euro zone must develop an exchange rate policy to protect the currency from "irrational movements". Germany has been cooler to any thoughts of exchange rate action.
"Since the last policy meeting the euro exchange rate has gone up as have short-term money market rates, which the ECB cannot ignore completely," said Citi economist Juergen Michels.
Even if it wanted to, the ECB's statutes mean it is ill-equipped to join a currency "race to the bottom".
Furthermore, the world's top central banks are expanding their balance sheets by printing money, or at least not reversing course, while the ECB's balance sheet is tightening, partly due to banks paying back early cheap money the central bank doled out last year.
A by-product of that could be to drive the euro yet higher.
IRISH DEBT DEAL
Although it took no monetary policy action, sources said the ECB and Ireland reached a compromise on a long-standing dispute over the cost of servicing money borrowed for a failed bank.
Dublin rushed through emergency legislation early on Thursday to liquidate failed Anglo Irish Bank as part of a compromise to avoid paying 3.1 billion euros a year until 2023 on money it took for the stricken lender during a meltdown of the main Irish banks in 2008.
Draghi merely said that the ECB "took note of the Irish operation" but a source close to the negotiations said that was tantamount to approval given the constraints of what he could say. That could go a long way to allowing Ireland to quit its bailout program this year.
Draghi gave a similar view on the state of the euro zone economy to the one he gave in January. Economic weakness was "expected to prevail in the early part of 2013" but later in the year, activity should gradually recover.
He said the move by banks this month to pay back early about 140 billion euros of cheap three-year money the ECB gave them last year was a positive sign.
"This reflects the improvement in financial market confidence," Draghi said, adding that the ECB would watch to see if the money market tightened conditions by stealth.
"We will closely monitor conditions in the money market and their potential impact on the stance of monetary policy, which will remain accommodative," he said.
A Reuters poll of economists last week suggested it would not change rates until at least July 2014.
Draghi was pressed about how much he knew of the derivatives scandal at Siena's Monte dei Paschi bank, and what he did about it when he headed Italy's central bank from 2006 to 2011.
Italy's third largest and oldest bank has been at the centre of a financial and political storm, facing losses of about 1 billion euros from a series of derivatives and structured finance trades and after a 9-billion-euro acquisition of smaller rival Antonveneta which left it badly weakened.
Draghi said there was no implications for the ECB's future role as a European bank regulator.
"The IMF has publicly stated that their preliminary view is that the Bank of Italy took timely and appropriate action within the limits of legal framework to address problems at (Monte dei Paschi)," he said. "Oversight was close and supervisory action escalated appropriately as (Monte dei Paschi's) problems became acute."
A senior Italian central bank source told Reuters this week that Draghi was informed of doubts raised by Bank of Italy inspectors but had little control over what has been widely criticized as ineffective oversight of the stricken lender.
He has already faced criticism with former Italian economy minister Giulio Tremonti said it was "stupefying" that in his role as supervisor of Italy's banking system Draghi failed to discover or prevent loss-making derivatives trades at Monte dei Paschi.
(Writing by Paul Carrel/Mike Peacock, Additional reporting Annika Breidthardt.Editing by Jeremy Gaunt.)
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