Finally, a good news story for Mario Draghi. A fairly uneventful ECB meeting, apart from one irate local journalist in Nicosia, saw Draghi and co. announce no new monetary measures, instead the focus was on the details of the QE programme, as we had expected. But Draghi also received a boost from the latest round of ECB staff forecasts:
The key points from this month’s press conference:
- The ECB QE programme will begin on 9th March.
- Draghi confirmed that purchases will be EUR 60 bn per month.
- Purchases will be carried out through to September 2016; however, they will continue to buy assets until the inflation rate is close to 2%.
- Draghi said that the Eurozone economy has already benefitted from the positive effects of QE.
- QE and negative yields: since so many European bond yields are now in negative territory, Draghi confirmed how low the ECB will go. Basically, it will buy bonds with yields that are no lower than -0.2%, the same level as the deposit rate.
- ECB staff forecasts for GDP: 2015: 1.5%, 2016: 1.9%, 2017: 2.1%. The forecasts for 2015 and 2016 were revised higher.
- ECB staff forecasts for inflation: 2015: 0%, 2016: 1.5%, 2017: 1.8%. The forecast for 2015 was revised lower, while the forecast for 2016 was revised higher.
- Draghi said that these upbeat forecasts “is no grounds for complacency” and the Eurozone still has a lot of work to do to get its economy back on track.
The interesting things to note from this press conference:
- The ECB remains committed to the QE programme it announced in January. There was no watering down of the proposals, it will still be EUR 60 bn a month, and the programme is essentially open-ended until the inflation rate gets back to close to 2%, currently it is -0.3%.
- The staff forecasts seem fairly optimistic for 2016 and beyond. The ECB is hoping that growth will bounce back this year and inflation will also pick up. While inflation could get a boost from the second half of this year as the 2014 decline in the oil price drops out of the index, growth could take longer to pick up to a more normal rate. It took the US five years, and multiple rounds of QE, before the unemployment rate dropped back to 2008 levels. Since the Eurozone economy is coming from an even lower base than the US, it could take a longer period of time and further support from the ECB down the line.
- However, because the ECB sees inflation returning to target over the medium-term 2 –year horizon, it takes the pressure off announcing any fresh monetary policy measures or boosting the size of its QE programme by the ECB in the coming months.
- Things may look rosy for the ECB today, but it may not stay that way.
The implications for the EUR
Draghi’s commitment to QE weighed on the EUR, which made a fresh 11-year low during Thursday’s press conference. After some whipsaw action, which saw EURUSD rise to a high of 1.1114, before falling to a fresh low at 1.1005, it closed the European session around 1.1040. Draghi’s soothing talk also helped to give European bonds a boost, with yields falling across the periphery and the core. Even Greek bond yields fell back on Thursday.
The longer term outlook for the EUR remains bleak, as relative monetary policy continues to favour a weaker EUR, as European bond yields sink at the same time as US yields continue to extend gains above 2.1%. We continue to think that a break below 1.10 is on the cards, which would open the way for a move back to 1.08.
However, we would urge some caution. The euro has seen no benefit from the better tone to the economic data of late, while the dollar is surging even though US economic data has been faltering in recent weeks. Thus, we are at risk from an overshoot to the downside for EURUSD, particularly if we get a strong US payrolls number on Friday. If this happens, then we could see short squeeze for the EUR at the start of next week.
The Jack Frost effect:
Winter Nonfarm Payroll numbers are never straightforward. We have the usual statistical errors to deal with alongside the weather effects, with vast swathes of the US covered in snow last month keeping people from finding a job, or employers from advertising. Thus, the bigger risk to the EUR in the next 24 hours could be to the upside for EURUSD, especially if payrolls miss expectations, which are currently an optimistic 235k, according to Bloomberg.
If that happens then we could see a short-term pullback, with key resistance for EURUSD coming in at 1.1241 – the high of the month so far – then 1.1679 – the high from 21st Jan. We continue to think that any strength will be temporary in nature.
Conclusion:
- Draghi and co. sounded more upbeat this month as the ECB staff’s growth and inflation forecasts were revised higher, however they remain committed to QE.
- This weighed on the EUR, boosted European stocks and also helped European bond yields fall across the core and the periphery.
- The EUR looks weak, and EURUSD could make a break below 1.10.
- However, there is a risk that EURUSD could overshoot to the downside, especially if we get a strong payrolls number on Friday. If this happens then we could get a short squeeze.
- Even so, we think that EURUSD could break 1.10 and target 1.08 in the coming weeks, and any period of strength will be temporary.
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