Where To Target The EUR As The ECB Exits The Currency War? - Danske

The ECB made an interesting policy shift at its policy meeting yesterday. At the press conference, ECB president Mario Draghi said that the ECB expected this to be the last policy rate cut and that it will instead focus on other unconventional measures, which it did with the expansion of QE to EUR80bn per month, the buying of corporate bonds and the introduction of a new series of longer-term refinancing operations (TLTRO II).

Admittedly, Draghi has previously said that the ECB had reached the lower bound on policy rates and then changed it later. Still, the signalling effect from yesterday’s meeting was very clear. Arguably, lower interest rates are the most direct way to influence the exchange rate. So, the ECB has, for now, exited the currency war, which it entered in June 2014, and instead is focusing on the credit/bank lending channel.

We find the ECB’s measures positive for risky assets as they, after all, are targeting the bank lending, credit channel and thereby economic growth rather than the currency channel, which is a zero-sum game. As such, the ECB’s decision is a further shot in the arm for equity and credit markets. In FX markets, the measures are bullish for the EUR against other low yielding currencies such as the USD, GBP and JPY.

We continue to see EUR/USD in a 1.05-1.15 range where a more hawkish Fed next week should cap the top side. However, the ECB exiting the currency war supports our long held view that EUR/USD will head substantially higher in 2016, eventually breaking the 1.15 level.

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