The ECB meeting for October was notable for a few reasons, firstly it disclosed details of the Asset Backed Securities (ABS) purchase programme, basically the ECB’s version of QE- lite. Secondly, Draghi switched the focus from further ECB action to structural reform implemented by governments and thirdly, maybe it slipped his mind, a la Ed Miliband, but Draghi failed to talk down the euro.
Cyprus and Greece join the ABS party
The bulk of this month’s press conference was given to explaining the ECB’s ABS programme. What we know about it is that the ECB will start purchasing bonds in the fourth quarter of 2014, and will start buying covered bonds from the second half of this month. Assets with a credit rating of at least BBB-/Baa3/ BBBI will be accepted, however there are some exceptions.
Assets based in Greece and Cyprus, both with credit ratings below this level, will be included in the programme, however, the ECB has formulated separate rules for them. This is a fairly brave move from the ECB, has it just opened the floodgates for lots of poor quality assets to linger on its balance sheet? If so, the ECB could turn into its own bad bank, which would be even worse for the currency bloc.
Whether or not the ECB is about to become a bad bank, could depend on the size of the programme, and the ECB is still being tight lipped about how big they expect the programme to be. One way to avoid taking on too many poor quality assets and becoming a bad bank is to limit the size of the programme, which could have implications for the eventual size of the ECB’s balance sheet.
Balance sheet expansion put on the back burner
This brings us to the next interesting observation from today’s press conference. Draghi was at pains to stress that his objective is not to target a certain size for the ECB’s balance sheet, but instead to meet the ECB’s chief mandate to maintain stable prices. This subtle shift could limit EUR downside, at least in the near term.
After last month’s ECB meeting the market perceived the latest policy measures as an explicit attempt to expand the balance sheet. However, one month on and the ECB seems to have backed away from an explicit balance sheet target. If the ECB will be happy to have a smaller balance sheet, as long as inflation picks up next year, then the downward pressure on the EUR could be more muted than first thought back in September.
Draghi goes back to 2012
Shifting its stance from balance sheet expansion to inflation targeting could have been designed to placate some of the powerful hawks at the ECB, most notably, the German Bundesbank. The best question of the day came from the CNBC Germany reporter, who asked if the ECB was worried about the rising tide of Euroscepticism in Europe’s largest economy.
This tide of political antipathy towards the currency bloc has risen in tandem with the ECB’s plans to increase the size of its balance sheet, she said. Draghi avoided getting dragged into national politics and instead said that the “euro is irreversible”, how 2012 of him…
Draghi may have dismissed the threat of a rising tide of euroscepticism in Germany, but deep down it may be keeping him up at night. Draghi kept reiterating how much the ECB has done in the last 2 years, how rates will not be falling any further, he also reiterated the job that governments still have to do, saying: “as regards monetary policies, euro area countries should not unravel the progress already made and should proceed in line with the Stability and Growth pact.”
Reading beneath the lines, this suggests to me that rather than invoke the ire of the German electorate, there will be no more QE measures, and instead member governments need to embark on more painful economic reforms.
Draghi pulls a Milliband
The one thing that could give the beleaguered member states a bit of a hand would be a weaker EUR, however, in the same way that the UK’s labour leader Ed Miliband failed to mention the deficit in his Party Conference speech last week, Draghi didn’t mention the currency in his scripted statement. When he was pressed by journalists to talk about the currency he said that the ECB did not target the exchange rate.
Thus, Draghi may have played his EUR put card. In the short term, Draghi may have put a floor under EURUSD, and Tuesday’s low at 1.2570 may be a temporary bottom for this pair.
The market perspective:
EURUSD has oscillated around 1.2650 since Draghi’s speech, and the next key event that could determine is future direction is tomorrow’s US payrolls report. Another sub-150k ready for NFPs could trigger a sharper pullback in the EURUSD downtrend, back towards the 1.2800 highs from 24th September.
However, the big picture still favours dollar strength over the EUR, so any pullback could be short lived and we continue to think that we could see back towards 1.20 in the coming months. Thus, any near term pull back to the 1.28 area could be greeted by a wave of selling pressure.
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