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ECB: Draghi’s magic works again…

Updated -  May 8, 2014 11:10:00 AM By Kathleen Brooks



ECB President Mario Draghi has a habit of getting what he wants. He has spoken out about the damaging strength of the EUR in recent weeks, and by the end of today’s ECB press conference the market started to play ball and EURUSD fell 120 pips. Draghi has past form at getting the markets to believe his rhetoric, remember the “whatever it takes” comment that signalled the end of the sovereign debt crisis in 2012? What is remarkable is that Draghi and co. at the ECB have not had to do anything to get the market moving in its favoured direction.

A press conference of two halves:

Thursday’s press conference could be divided into two halves. Looking at the first half, the ECB statement was fairly standard. It included a line on the “moderate recovery in the economy”, inflation remains low although over the medium term inflation expectations remain “firmly anchored”. The ECB President also reiterated the Bank’s forward guidance and pledge to keep interest rates “at present or lower levels for an extended period of time.”  As Draghi read out his statement the EURUSD rallied to within a whisker of 1.40, however, then the second half of the press conference started and things began to change for the EUR. As Draghi got stuck in to the Q&A he was asked about deflation, the exchange rate and the prospect for further policy action.

Why is the EUR lower?

Draghi said that the ECB is ready to take further action in June, if necessary, to fight off deflation and he was very clear that a strong EUR was weighing on inflation and he wasn’t comfortable with it. Although the ECB President has said that the Bank remains ready to act in the past, the fact that he said action could be taken as early as next month has made the market take notice. The ECB releases its latest staff growth and inflation forecasts at the June meeting, if inflation is revised lower for the next 1-2 years then the ECB may have no choice but to take action to protect its mandate, which is price stability.

The market appears to be lower on the back of Draghi’s comments, however, the ECB never pre-commits to policy action, so just because Draghi said that the EBC is ready to act next month, does not mean that it will actually do so. A couple of things will be crucial, firstly, whether we see a fall In prices for May, and secondly, if the weaker than expected April CPI print causes the ECB to revise lower the staff forecast for inflation this year and next. If this happens then we think further action in on the cards.

We think there is a 40-50% probability of action at the next ECB meeting, however we think any action could be small. The ECB may look to cut interest rates further (they are currently at 0.25%) or implement a small negative deposit rate, we continue to believe that radical action like QE still seems unlikely.

EURUSD stuck in a range:

In our view, the EUR is lower based on a vague pledge by Draghi, who has a track record of not delivering when it comes to price action, so this sell off could be premature. We think that in the lead up to the June meeting EURUSD could remain range bound. The failure to break through 1.40 suggests that this level could be a top for this pair in the coming weeks, while support lies at 1.3815 – the low from 2nd May, and then 1.3722 – the top of the daily Ichimoku cloud and a key level of support.

Conclusion:

Overall, Draghi proved that when he wants a weaker EUR he gets it. Surprisingly in our view, the ECB does not seem to be losing credibility even though the Bank appears reluctant to pull the policy trigger. However, we think that the downside in EURUSD could be limited ahead of the June meeting, where the ECB may adjust policy for the first time since November 2013.

From a currency perspective, Draghi talked the EUR higher and then talked it lower. With all eyes on the June meeting, we could be subjected to a 1.3700-1.40 range until June.  With GBPUSD still hovering close to 1.70, the Bank of England Governor Mark Carney may be asking Draghi for tips on how to cool your currency.

Figure 1:

Source: FOREX.com

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

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