Good morning,
We told it you it would be volatile!
The European Central Bank finally outperformed market expectations in its policy announcements although one single comment sent the euro flying higher on what may have been one of the most volatile days for the euro ever. While the deposit rate cut further into negative territory was widely expected, everything else that Draghi and the European Central Bank opted for was bigger, brighter or more surprising than analysts had hoped for.
All interest rates that the European Central Bank operate were cut and QE extended by EUR20bn a month. Also the bank is now planning on purchasing corporate debt to free up large corporates’ ability to invest in capital and increase productivity. So far, so stimulatory.
But by launching a TLTRO – Targeted Longer-Term Refinancing Operation – that allows banks to borrow at negative rates i.e. get paid for borrowing is a subsidy to European banks that should insulate the financial system from the unwanted effects of negative deposit rates. This is the kind of financial policy engineering that may allow for a near term pick-up in inflation expectations and, maybe more importantly, a calming of fears around financial stability.
So did he mess up?
Draghi’s press conference may not have been his most successful but I think it was his bravest certainly. Previously markets would have been happy with a decent slump in the euro and a central banker telling them there is more where that came from. We’ve got used to using EUR as a barometer of ECB performance. This is unfair in my opinion; Draghi and the ECB did well today, one comment apart.
I have no idea why Draghi decided to tell us all that “From today’s perspective, and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further”. Normally he says “we don’t pre-commit” or finds another way to not answer the question. He really surprised markets and sent the euro rocketing.
This could easily be part of a larger plan to shift the focus of how policy is transmitted into the real economy away from the exchange rate to credit and bank borrowing.
That’s brave in a world in which everyone is talking about newly, more negative interest rates. I hope it works.
So what does this mean for the euro?
There is a lot of shrugging going on in currency markets at the moment; everything is a bit of a mess. The one thing that Draghi’s moves yesterday did was put the onus back on Federal Reserve, the Bank of England and other central banks to take care of their own currencies. If you want a stronger dollar it’s going to have to come from the Federal Reserve hiking interest rates based on strong economic data. Likewise in GBPEUR, if we see a referendum vote that allows the UK to stay in the EU then we should see a retracement higher.
And why shouldn’t we? Lost in the fog of the ECB meeting was a fantastic jobless claims number from the States which is dollar positive and, from an EU referendum perspective, do you honestly think the Queen said that? Substitute in the words “Rupert Murdoch” into the piece and the issue becomes a lot clearer.
All importantly, with Draghi seemingly putting in a floor in rate expectations should we see a pick-up in Eurozone inflation and growth the scene is set for euro strength.
The Day Ahead
Markets are going to take a few sessions to work through these plans we feel. Let’s just hope that it is done in a less volatile manner.
Have a great day and a fantastic weekend.