On the surface, ECB President Mario Draghi’s press conference didn’t tell us anything new, however, if you dig a bit deeper, this could be one of Draghi’s most illuminating conferences in recent months for a few reasons.
Firstly, Draghi is concerned about the deteriorating geopolitical picture, especially the potential trade war with Russia, the EU’s third largest trading partner. Secondly, the ECB is continuing to progress with its review of a potential asset purchase programme for the currency bloc, and lastly, Draghi talked down the EUR by saying that monetary policy in the Eurozone is on a divergent path to that of the US and UK, and will continue to be so for a long time.
The latter point is worth noting as it suggests that Draghi is comfortable with loosening policy even as other major central banks are starting to normalise monetary policy. At the start of this year Draghi was concerned that rising Treasury yields would put upward pressure on Euro-area yields, however that is now not the case.
As you can see in figure 1,Germany 2-Year yields, a good gauge of monetary policy expectations, are at 0%, while the equivalent US yield is 45 basis points higher. ECB’s Draghi seemed to give the market the green light to continue to view the Eurozone as being on a divergent policy path from other major economies for the long-term, which could keep the EUR subdued for some time.
Considering growth in the Eurozone is going into reverse even with the interest rates at record lows, Draghi’s comments on divergent monetary policy and the EUR seem fairly expedient, as a weaker currency may be the last option left to try and save the Eurozone’s fledgling recovery.
However, Draghi obviously can’t admit that the currency is the ECB’s last line of defence, so instead he kept referring back to other potential options to boost the economy, such as purchases of asset-backed securities (ABS).
The EUR has been on a downward slope this afternoon that was triggered by Drgahi saying that a weaker currency is justified by the fundamental, and EURUSD is close to Wednesday’s low at 1.3333- the lowest level since November 2013. While a 50 pip move in EURUSD post a Draghi press conference feels fairly mild, in these sluggish summer markets this is worth writing about.
As we said earlier, the next key levels of support to watch are 1.3296 – the low from 7th November, and then 1.3245 – the 31.8% retracement of the July 2012 – May 2014 advance.
ECB – about to step into the big unknown?
Draghi said that plans for an ABS purchase programme were on-going; however, he was fairly vague on the details. When he was asked by a reporter if this would be the ECB’s version of Fed-style QE he was fairly hazy on the details, saying that it would be a form of QE, but that QE has many forms, hmmmm…
He also mentioned that the ECB was looking into engaging the services of a consultant to manage the planning of an ABS purchase programme, however he was tight-lipped on whom this may be. Maybe he should give his old pal Ben Bernanke a call to see if he would be interested in working in Europe for a while, after all initiating the world’s largest QE programme is high up on his CV.
On a more serious note, today’s press conference suggested that outright asset purchases are still some way off for the currency bloc, and the ECB could try and talk down the currency for a few months before embarking on anything as radical as QE.
The growth outlook:
Draghi continued to insist that the medium-term inflation outlook remains stable, even with price pressures at a mere 0.4% YoY. He also said that the recent decline in prices was down to energy prices; however he added that the risks were very much to the downside.
For now, the ECB seems comfortable with prices just hovering above zero, however next month’s ECB staff forecasts could revise the price outlook for this year and next even lower, which could force the ECB to embark on a policy response sooner than it may be comfortable with.
On the growth front, Draghi didn’t seem overly concerned about the recent sluggishness in activity; however he noted the challenges to growth in the region and also the risk from geopolitical tensions. Draghi pointed out that it is difficult to know how these tensions could impact the Eurozone, but he singled out events in the Ukraine, and the recent counter-sanctions imposed by Russia as the biggest cause for concern.
Conclusion
Overall, we think this meeting was fairly sleepy, as is typical of August ECB meetings, and the focus should be on September when we get the next round of ECB staff forecasts. By then we should know more about the potential impact from Russian sanctions and also what this means for the Eurozone economy.
Until then we expect EURUSD to drift lower, with 1.3245 – the 31.8% retracement of the July 2012- May 2014 uptrend, as the next major level of support.
Figure 1: 
Source: FOREX.com and Bloomberg
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