Euro Fails to Hold Onto Gains Despite ECB Optimism

Euro soared above 1.19 on the back of the European Central Bank’s monetary policy announcement. The ECB was less dovish than anticipated but the single currency failed to hold onto its gains as Brexit risks mounted and US stocks staged an early reversal. Central Bank President Lagarde was far more nonchalant than investors feared as she urged the market not to overreact to euro gains. She admitted that the euro was discussed but they do not target the exchange rate and instead watches its effect on inflation.

The central bank also raised its GDP forecasts for 2020, 2021 and 2022 and boosted its 2021 inflation forecast. After this month’s record low CPI report, investors worried the ECB would lower its inflation projections but these upgrades are a reflection of their confidence in the economy. In fact, Lagarde said data suggests a strong rebound with manufacturing activity picking up and domestic demand recovering significantly. She admitted that uncertainty remains and ample stimulus is still needed but the main takeaway from ECB is they are far less concerned about the economic outlook than euro traders anticipated. While it can be argued that the reversal in the euro reflects the market’s skepticism, it may have more to do with risk aversion and worries for Brexit blowup in Europe. With that in mind, we expect euro to outperform sterling, weaken against the Japanese Yen and struggle for direction against the US dollar.

Unlike euro, which still ended the day up against the greenback, sterling sold off sharply. In the last 7 trading days, GBP/USD dropped nearly 600 points while EUR/GBP rose more than 300. Its looking more and more like Prime Minister Boris Johnson will push for a hard Brexit. The government refuses to withdraw their internal market bill which the European Union argues breaches their agreement. They have given Johnson to the end of the month to amend the bill. US House Speaker Nancy Pelosi warned that the US would not support a US-UK trade deal if Britain violates the EU withdrawal agreement. Things are getting messy at the worst time possible with new virus cases on the rise and the economy struggling to recover. Further losses are likely in sterling as investors watch the drama unfold – we don’t expect tomorrow’s industrial production and trade balance reports to distract from the bigger story.

Meanwhile, despite stronger than expected producer prices and another week of jobless claims below 900k, the US dollar was mixed. It was flat against the Japanese Yen and Australian dollar, sold off versus the euro and Swiss Franc and strengthened against sterling, the New Zealand and Canadian dollars. Comments from Bank of Canada officials failed to have a lasting impact on the loonie. With the Fed’s new inflation strategy, many people were wondering if the BoC would make adjustments as well. Central bank Governor Macklem did not shed much light on this but he did say their Quantitative Easing program is aimed at achieving their inflation mandate. New Zealand manufacturing PMI numbers are scheduled for release this evening.