Why ECB Will Do Nothing

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Market Drivers for April 24 2014

RBNZ hikes 25bp hints more to come but kiwi fails to hold 8600

GE IFO better than forecast as Ukraine no impact on Germany, Draghi speech recycles old themes

Nikkei -.97% Europe 0.75%

Oil $101/bbl

Gold $1283/oz.

Europe and Asia:

NZD RBNZ hikes 25bp

JPY CSPI 0.8% vs. 0.7%

EUR IFO 111.2 vs. 110.5

North America:

USD Unemployment claims 8:30 AM

USD Core Durable Goods 8:30 AM

The euro remained bid in morning European trade today as latest IFO reading showed no signs of deterioration of sentiment amongst German corporates while the kiwi could not hold the post RBNZ rate hike highs as it faded off the 8600 level.

In Europe the IFO report came in at 111.2 versus 110..5 eyed – an improvement from last month’s reading of 110.7 as German businesses are clearly not being affected by the geopolitical tensions in the region. According to IFO economist Klaus Wohlrabe positive fundamental mood prevailed in Germany and orders were full, with exports doing well and capital goods sector performing especially strongly. There was just a minor decline in current conditions dropping to 115.3 versus 115.7 forecast. Overall this was a solid report and was just another data point to convince the market that the ECB is likely to remain stationary at its next meeting in May.

The consensus view amongst analysts now is that despite the constant rounds of jawboning, the ECB officials will not even consider a move towards a more accomodative bias until June, as recent data from the region has been generally supportive. Most importantly the data from Germany has not seen any deterioration and therefore the pressure to act has been greatly reduced.

In his speech today Mr. Draghi once again reaffirmed the key policy points that he has been making for the past few months – namely that the central bank stands ready to use all tools at its disposal including negative interest rates and QE via purchases of asset backed securities in order to combat deflationary threats. However, as many analysts have pointed out those policy choice face many serious problems.

A move towards negative interest rates could prove to be politically disastrous as savers would literally see their funds on deposit decline in absolute terms. Although purchasing power may not fall – that may be of little comfort to average retail savers who could experience a loss of capital.

With regard to using QE in order to purchase asset backed securities the ECB could have better traction with that idea, but the market for such products is very small in Europe and therefore such a plan could have minimal policy effect.

A much better idea, proposed by some analysts is for the ECB to simply purchase US Treasuries which would avoid the problem of choosing which European sovereign debt to buy and would help to drive the exchange rate down – a key concern of policymakers as EUR/USD inches ever closer to 1.4000. However such a move is seen as politically untenable and therefore the ECB is unlikely to even consider it.

In the end Mr. Draghi’s speech appears to have been more bark than bite, as the central bank remains stymied in its choices and under no immediate threat to act. At the very most the ECB could take rate up to but not below the zero barrier, but even if it chooses to do so, it is unlikely to make any moves before June. The euro therefore has remained relatively well bid with strong support at the 1.3700 level but the pair is also capped ahead of the key 1.4000 figure as traders fear a more serious response from the central bank should the unit breach that level. In short for now the pair remains rangebound in a low volatility environment.

Boris Schlossberg
Managing Director

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