global perspectives

Draghi’s Euro push back has no bite

Salman Ahmed, PhD - Chief Investment Strategist

Salman Ahmed, PhD

Chief Investment Strategist
Charles St-Arnaud - Senior Investment Strategist

Charles St-Arnaud

Senior Investment Strategist
Jamie Salt, CFA - Systematic Fixed Income Analyst and Portfolio Manager

Jamie Salt, CFA

Systematic Fixed Income Analyst and Portfolio Manager

As we expected, the ECB kept its statement unchanged alongside no change in policy.

This stance was somewhat dovish given the “robust” growth environment in the Eurozone – something that Draghi acknowledged. That said, the key points emerged at the press conference, where Mr. Draghi tried to push against the recent sharp appreciation in the Euro, albeit not to the same extent as other ECB members, who have been speaking on this topic in recent days.

Markets behaved to the contrary, briefly pushing the single currency above 1.25 against the USD. This disconnect between Mr. Draghi’s attempts to “jawbone” the Euro lower and the market’s reaction needs to be understood within the context of the future path of monetary policy: the continued strength of the single currency appears consistent with pressures the ECB is likely face going forward, given the very strong growth environment.

Although inflation remains low and below target, the ongoing extra-ordinary stimulus seems out of synch with the economic realities that hawks in the ECB’s governing council are currently focusing on, namely: growth, the size of the balance sheet, and policy exit risks. In addition, the USD has itself been under pressure due to domestic factors, most recently in the form of comments by US Treasury Secretary Mnuchin – which Draghi viewed as contravening the G-20 agreement on avoiding currency wars. Given this, and in the absence of concrete signs of a FX-induced policy shift, it seems unlikely that the ECB will be able to exert any tangible pressure on the exchange rate. It is important note that the ECB’s concerns regarding the Euro are mainly related to the pace of the appreciation rather than with the level of the single currency, given the pace of the appreciation is what matters for core inflation.

We also had a flavour of ECB policy-making complexities when Mr. Draghi tried in vain to water down the discussion about potential end date for quantitative easing, which was disclosed in the December policy meeting minutes. Given the growth environment and rising influence of hawks in the council, we think that the likelihood of QE ending in September is now well above 50%. We believe the ECB will start to articulate this plan publicly in coming weeks (a delicate point in itself given the current low inflation environment and stronger currency). That said, the likely timing of the first rate hike is still H1 2019 in our view. Rate moves was an area of discussion Mr. Draghi was more assertive on, mentioning that the chances of a rate hike in 2018 are very low. We think an early-end to the QE program might be coupled with unchanged guidance on rates to widen buy-in within the governing council, which supports our expectation for H1 2019. 

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