Dear prudence

The euro fell sharply this morning after a Bloomberg report that said Mario Draghi’s remarks yesterday were misinterpreted.

The ECB President commented yesterday that they are seeing reflationary pressures rather than deflationary pressures – a marked departure from his recently cautious outlook. Investors took this as an indication that the bank would not only move away from their substantial stimulus program, but proceed toward tighter fiscal policy in general.

Draghi’s speech was not intended to point to a more hawkish policy stance. Rather, it spoke to a balance between recognizing economic strength in the euro area and warning that monetary support is still needed, according to the report. This emphasizes Draghi’s calls for prudence in scaling back stimulus.

While briefly dipping below 1.13, the euro has recovered and is trading back near yearly highs.

The big picture

What does this mean for the euro going forward?

Investors are focused on the big picture. Draghi punctured his speech with multiple caveats allowing for maintaining current policy, so these comments are not so off the wall.

Maintaining that stimulus was still necessary for now, the ECB President’s more optimistic outlook on inflationary pressures lays the framework for the future. Acknowledging this landscape gives policymakers the scope to scale back ultra-loose monetary policy. By making investors aware of it now, they are allowing them to price this in and avoid future disruption.

Poised to strike?

The ECB isn’t the only central bank considering tighter monetary policy. Bank of England Governor Mark Carney said just this morning that he would consider voting to increase interest rates in the UK.

Three members of the Monetary Policy Committee (MPCs) voted to raise rates in the most recent BoE meeting. Hi swing towards this camp is important. As the Financial Times notes, Carney has never voted with the minority on the MPC since coming to the bank in 2013.

Previously, the Governor has taken a more cautious tone due to rising inflation depressing wages and consumer purchasing power – ultimately leading to weaker domestic pressures on consumption. Carney notes that he would need to see this offset with higher business investment to tighten policy.

EURUSD: After tumbling almost 0.8%, the euro has shrugged off much of the Draghi doldrums to trade near yearly highs.

GBPUSD: Sterling took a massive leap higher after BoE Governor Carney indicated that he could vote to raise interest rates this year

AUDUSD: Aussie dollar higher after iron ore prices saw their biggest gain in four months.

USDCAD: Canadian dollar higher against the greenback as oil prices move higher.

USDJPY: The yen trading mostly flat against the greenback as investors balance risk-appetite with a weaker dollar.