The ECB and BOE both kept monetary policy on hold in March, which has helped to boost the EUR and GBP this afternoon. Although the majority in the market expected the ECB and BOE to remain on hold, there was a small chance of a rate cut at the ECB and more QE at the BOE, hence the “relief” rallies in the two currencies this afternoon.
Draghi strikes an upbeat tone
Looking at the ECB first, Draghi was a little more “upbeat” than expected at this meeting, which also helped the EUR to move to its highest level so far in March. The key things to take away from Draghi’s press conference:
• ECB staff forecasts for growth were revised down slightly to -0.9%- -0.1% this year, and 0%-2% in 2014
• ECB staff forecasts for inflation were broadly flat for March, at 1.2%- 2% for 2013 and 0.6% -0 2% in 2014
• Draghi said that he doesn’t see deflation risks, which is quite a shift from last month when he said that the strength of the euro could weigh on price. This could suggest the ECB is happy with the decline in the euro in the last month.
• Draghi also didn’t mention the level of the EUR in his press conference.
• In response to a question , Draghi said that the exchange rate is in line with long-term averages, says FX rate is not a policy target, although it is important for growth and inflation.
• He said that monetary policy will remain accommodative as downside risks remain to the Eurozone’s growth forecast. He also pressed governments to implement fiscal and structural reforms.
• Regarding Italy’s election – his only comment was that the election uncertainty has not caused contagion to spread to the markets.
Overall, Draghi was not giving anything away today. He reiterated that the ECB does not pre-commit to policy changes. Although he said a rate cut was discussed this month, right now a rate cut in the coming months does not look like it will be forthcoming. The ECB stands ready to use the OMT programme; however peripheral bond markets have continued to recover, suggesting that the OMT may not be needed for some time.
What does this mean for the euro?
Today’s meeting is mildly positive for EURUSD. In the aftermath of the meeting EURUSD tested fresh March highs at 1.3095. The next resistance level of note is 1.3165 – the base of the current daily Ichimoku cloud. While the euro could drift higher from here, we think that gains will ultimately be capped. As we found out in February, Draghi is willing to alter his rhetoric when the strength of the euro becomes unacceptable, so we could see gains limited to the 1.3250-1.3350 zone, just below the EURUSD 10-year long-term average rate.
EURJPY had a sharp move higher and is now looking overbought. However, we think any dips will be shallow. This euro cross could have the best chance of rallying from here as the ECB’s neutral stance contrasts with expectations of an age of unprecedented austerity at the BOJ under new governor Kuroda. In this cross 125.00, then 127.70 are key medium-term resistance levels, while 121.00 – the 50-day sma –may also act as support from here.
Bank of England holds steady again
The BOE kept rates and QE purchases steady in March, which defied some in the market who thought it would add to QE. We believe the decision was probably tight (we will find out just how tight when the BOE releases the minutes for today’s meeting on March 20th), however we believe the clincher may have been improvement in the service sector PMI for February and also the better than expected BRC retail sales number for February.
The BOE does not release a statement when it keeps policy on hold, so the method behind its decision is still unknown. Likewise the market is none the wiser regarding its potential future actions. However, we think that more QE is on its way, the question now is when could we get more QE from the BOE? In the absence of a major economic shock or spike in financial market volatility in the coming weeks we would expect the BOE to wait until the May meeting before doing more QE as this is an Inflation Report month, which is traditionally associated with the BOE changing policy. Thus, the markets are likely to be extremely sensitive to UK data releases in the coming weeks to see if it signs of economic decline could cause the BOE to pull the QE trigger in April.
The impact on the pound:
Because there was some expectation of more accommodative action from the BOE today, GBPUSD rebounded after the decision. It jumped as high as 1.5075 after the announcement, after falling as low as 1.4970 before the news. Likewise, EURGBP dropped back to 0.8650. Sterling strength against the euro was short lived as the ECB turned out to be less dovish than expected, and EURGBP was testing 0.8700 resistance at the time of writing. We think that the outlook for GBP is fairly bleak and gains could be capped at 1.5105 in the near term, there are two reasons for this. Firstly, the BOE may have remained on hold today but we think that more QE is coming, especially under the stewardship of Mark Carney. Newspaper reports today suggest that the government could raise the BOE’s target rate for inflation as early as the Budget on 20th March, which would open the door to more aggressive QE later this year. The second reason is that GBPUSD will also depend on the dollar. If tomorrow’s payrolls report is strong, as some expect, this could boost the greenback and we could see GBPUSD drift lower in the medium-term. We believe that GBPUSD could fall below 1.50 in the coming days. Support lies at 1.4950 initially, then 1.4700 in the medium-term.
Figure 1:
