Don’t Mess with the ECB

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What a morning it has been in the forex market! The euro shot above 1.32 after the European Central Bank’s rate decision but sold off aggressively when Mario Draghi said the ECB has an “open mind on negative deposit rates.” Before the rate decision, we said a rate cut alone would not kill the euro rally, instead the ECB needed to be willing to do more and Draghi wasn’t messing around when he said that “all options are open” and the “ECB stands ready to act if needed.” The central bank delivered in a very big way today by cutting their main refinancing rate by 25bp, their lending rate by 50bp and extending their fixed rate allotment until July of next year – their willingness to consider negative deposit rates was just icing on the cake.

Based on the ECB’s actions today and the number of times Draghi used the word weaker in his introductory statement, the central bank is very worried about the outlook for the Eurozone economy and lack of lending. More specifically, Draghi pointed to weak labor market conditions and short-term indicators as reasons for why easier monetary policy was needed. He also said growth weakness has now expanded beyond the peripheral and is affecting core economies. With inflationary pressures declining on the back of lower price pressures, now was the perfect time for the ECB to ease.

Yet the central bank did such a great job of preparing the market for a move before the announcement that the rate cut itself did not hurt the euro much. Instead expectations for future monetary policy actions killed the euro rally because this is not a one and done scenario according to Draghi. In the long run, the measures taken today will provide underlying support for the Eurozone but given how low rates have been for the past few months, we are skeptical abut how much real impact it will have on the economy.

Aside from the euro, USD/JPY is also on the move today. Investors initially drove the currency pair above 98 when EUR/JPY was being bought but Draghi’s comment about negative rates also sapped USD/JPY’s rally. However the pullback was not as deep because the dollar was supported by better than expected data. U.S. jobless claims dropped to 324K this week, its lowest level in more than 5 years. Continuing claims edged higher but the increase was small. The country’s trade deficit also narrowed 11% to -$38.8B from -$43.6B. We are finally seeing some good news for the U.S. economy and this should keep the dollar supported on a day when the ECB not only cut interest rates but says they are open to easing again if necessary. Non-farm payrolls are scheduled for release tomorrow and jobless claims have been consistent with an uptick in job growth.

Kathy Lien
Managing Director

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