EUR – Key Takeaway from ECB Draghi’s Comments

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Comments from European Central Bank President Mario Draghi sent the EUR/USD lower. As expected, the ECB left interest rates unchanged at 0.75% and the real action was during Draghi’s post monetary policy meeting press conference. While most of his comments were unchanged from last month, his concern about the downside risks in the second half and admission that the ECB will continue to assess incoming data and stand ready to act indicates that the central bank is still open to idea of additional easing. Another rate cut remains on the table and as long as that’s the case, EUR/USD may have a tough time recovering.

Lets not forget that while the European Central Bank and the Federal Reserve are both currently engaged in aggressive monetary easing, the ECB is debating over the need to increase stimulus whereas the Fed is debating over tapering asset purchases. This divergence in the potential directional of monetary policy should play a key role in the outlook for the EUR/USD. The key takeaway from Draghi’s comments today is that they haven’t shut the door on additional easing. The ECB’s concerns center on weak consumption and failed structural reforms but Eurozone growth should benefit from a recovery in global demand, if that ever happens. We believe that the downside risks for the Eurozone are realistic and likely to increase in the coming months especially if global equities correct.

The sell-off in euro moderated when Draghi said the problems in Cyprus reinforced the central bank’s determination to support the currency and while Cyprus is “no template” for a future bailout, these comments suggest that the ECB will be involved quickly if another country were to face the same problems. Draghi also used this opportunity to push the idea of a Single Supervisory Mechanism, which would lay the foundation for a banking union. He said, there is no better way to prevent a crisis than through SSM.

Meanwhile the biggest mover today is USD/JPY, which is up more than 2.5% as the Bank of Japan’s easing measures last night satisfied investors. The Bank of Japan expanded its JGB purchases to 40 year bonds and this means all JGB maturities are eligible for purchase. They increased their target purchases to an annual pace of JPY60-70 trillion, translating to about Y6 trillion a month, up from a prior level of Y3.5 trillion. As expected, the BoJ also merged its APP program with Rinban operations and abolished the banknote rule. With this bold and aggressive easing, we believe that the correction in USD/JPY is over. The currency pair is now trading above 95 and should be on its way 100.

Kathy Lien
Managing Director

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