A hawkish Draghi takes markets by surprise
Date: Friday 07 Mar 2014
The general reaction to the European Central Bank's (ECB) monetary policy meeting and subsequent press conference on Thursday was one of surprise after the bank took no action.
The ECB defied not only a handful of analysts that expected an easing of monetary policy but also calls from the International Monetary Fund to cut rates and start its own quantitative easing (QE) programme.
A significant amount of analysts had been looking either for an interest rate cut or the end of Securities Markets Programme sterilisation. What was not expected was for ECB President Mario Draghi to take on a hawkish tone and make some upbeat comments about the outlook for the European Union. In other words, he did not hint at any immediate plans to ease monetary conditions further.
A Wall Street Journal (WSJ) article cited two analysts who were surprised. "I'm a bit surprised that Draghi isn't making a case for further easing in any meaningful way, so they remain comfortable with current economic performance," said Geoffrey Yu, a currency strategist at UBS in London.
Marc Chandler, a currencies analyst at Brown Brothers Harriman, said the euro's rally came "in response to the ECB's lack of action and Draghi's apparent lack of urgency. Although some observers had favoured an April move, Draghi's tone makes this seem unlikely as well".
Draghi does not bother to talk down the euro
Kathleen Brooks, research director for FOREX.com, said how Draghi did not even bother to talk down the euro like in past occasions.
"At this meeting Draghi sounded far less concerned with EUR strength, saying that the currency is not a policy tool. He also added that the improvement in the recent PMI surveys has been encouraging, suggesting that the ECB is happy with the growth outlook even with the EUR close to 2011 highs," Brooks said.
"Overall, the ECB meeting was more upbeat than some had expected, which triggered a rally in the EUR. The ECB seems happy to leave policy unchanged and they don’t seem particularly concerned with the strength of the single currency, which has been used as a green light by the bulls on Thursday."
New ECB forecasts do not prompt Draghi to act
What made Draghi's reluctance to take action most surprising was perhaps that the ECB lowered its 2016 inflation forecast to 1.5%, well below the ECB's medium term inflation target of just below 2%. Draghi pointed out that the fourth-quarter inflation forecast is 1.7% but while that is still low, he took reassurance from higher GDP growth forecasts and the recovery's likelihood to lift prices after an "extended, protracted period of time".
Despite supposedly having all the information necessary to act this month, as he recently suggested, many analysts still believe the ECB will act later this year.
Tom Rogers, senior economic adviser to the EY Eurozone Forecast, said: "One of Mario Draghi’s comments was very interesting though – he pointed out that with borrowing costs set to remain where they are for an extended period of time, and with rising inflation, real interest rates would fall in 2015 and 2016, meaning an effective easing in monetary policy. If it is desirable that monetary policy be looser (and we wouldn’t disagree), then it seems odd that with Eurozone unemployment at 12% right now, the ECB wouldn’t seek to ease policy in 2014 rather than waiting a year or two for it to happen de facto."
Nonetheless, Rogers actually expects inflation to rebound faster than the ECB's forecast, with the key difference being that the ECB assumes a stable exchange rate while his team expects the euro to depreciate by around 10% by the end of 2016.
According to Craig Erlam, Market Analyst for Alpari UK, it should come to no surprise that Draghi went on the offensive at a time when inflation appears to have stabilised at 0.8% because "the ECB has never been known for its radical policies".
End of SMP de-sterilisation?
Erlam pointed out that Draghi effectively dismissed the idea of de-sterilisation of bond purchases, claiming it would be too short term due to the length of the maturities on the bonds, being one to three years. "Of the more conservative options remaining, that only leaves a small rate cut to 0.1% and I have the feeling, with little room to manoeuvre, that option may be kept for a rainy day," he said.
Thus, if there is one conclusion to this month's meeting, it could be that one of the measures in the ECB's toolkit has already been ruled out.
Price levels
In terms of upcoming price leves for the EUR/USD, Kathy Lien, Managing Director for BK Asset Management, pointed out that the currency pair has been taken above an important long-term Fibonacci retracement level at 1.3835/40, where a "sustained break [...] would open the door for a move up to the two-year high of 1.3892."
Above this level, Brooks of Forex.com pointed to the resistance levels at 1.3958, the top of the monthly Ichimoku cloud, and 1.40, a key psychological level.
JP
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