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ECB Preview: Draghi to hit the euro when it’s down? 5 topics to watch out for
The euro has certainly fallen, but this isn’t reflected in inflation. Will Draghi call for patience, expressing optimism but risking a rise in the value of the euro? Or will he keep pushing the “ready to do more” mantra and hit the euro when it’s down, sending EUR/USD to the comfort zone closer to 1.20?
Here is a preview of the Draghi show, listing 5 topics to watch out for.
Background
Monetary policy divergence is certainly reflected in the markets.
Basically, the ECB is set to keep low rates for at least two more years, and expand its balance sheet, while the Fed is about to end its balance sheet expansion (QE3) and raise the rates in 2015.
After the ECB surprised with further measures in September (after the big steps in June), the euro continued falling. The US dollar also reacted to upcoming tightening, despite seeing some unconvincing figures, namely August’s weak NFP. EUR/USD is consistently falling, making only “dead cat” bounces on the way.
Euro-zone woes
The euro-zone experienced flat growth in Q2, with Germany contracting by 0.2%. German PMIs did not foresee this fall, and the most recent manufacturing PMI from the zone’s locomotive is now in contraction. In addition, business confidence is falling and unemployment is rising.
France isn’t in a better state: the second largest economy suffered a political crisis, refuses to reform and hasn’t seen growth in a long time.
The old continent is still experiencing low inflation. CPI is at 0.3% and core CPI at 0.7%, both are at the cycle lows. While both have already been at these levels, it hasn’t happened together until now. German inflation is at 0.8% and Spain continues suffering from outright deflation.
Inflation comes via lower energy prices, glut resulting from sanctions on Russia and counter sanctions and the higher lending from banks is only marginal so far – it does not contribute to stronger inflation.
The first move to enlarge the balance sheet came from the first installment of the ECB’s targeted loans, known as TLTROs. The reception was poor: nobody wanted Draghi’s money, or to be precise: only €82.6 billion were taken up, below all estimates. This raises expectations for more steps and triggers even more worries about the economies of the euro zone.
ECB toolbox
What is the ECB going to do now? Well, probably nothing. It did so much in September and declared that interest rates as having reached their lower bound, that no action is expected now.
So, it all depends on Draghi’s words. Here are the topics:
What do you think? Will the euro suffer from Draghi’s heavy hand once again? Or will it finally recover?
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The EURUSD had a narrow range day yesterday and is likely sidelined waiting for today’s European Central Bank (ECB) interest rate decision and monetary policy statement and press conference.
Euro zone PPI falls 0.1% in August
Producer price inflation in the euro zone fell for the second consecutive month in August, underlining concerns over the threat of deflation, official data showed on Thursday.
In a report, Eurostat said that its producer price index eased down by a seasonally adjusted 0.1% in August, compared to expectations for a decline of 0.2%. Producer prices inched down 0.2% in July.
Year-over-year, the producer price index declined at an annualized rate of 1.4% in August, worse than forecasts for a drop of 1.2%. Prices fell at a rate of 1.3% in July.
EUR/USD was trading at 1.2640 from around 1.2644 ahead of the release of the data, while EUR/GBP was at 0.7812 from 0.7815 earlier.
Meanwhile, European stock markets remained lower. The DJ Euro Stoxx 50 fell 0.7%, France’s CAC 40 shed 0.5%, Germany's DAX dipped 0.4%, while London’s FTSE 100 inched down 0.5%.
Mario Draghi will announce during the day reinforcing stimulus measures, keeping the interest rate unchanged at 0.05% reference.
With these measures, the USD may continue to weaken against other currency, especially USD, taking into account the recovery of the American economy.
3 things to watch for at the ECB meeting
Inflation is at a five-year low, unemployment is stubbornly high and powerhouse Germany is showing signs of heading into stagnation. In other words, the eurozone economy is still struggling. That’s why all eyes will be on Mario Draghi on Thursday and whether the European Central Bank has anything up its sleeve to help out the currency union. Here are the main things to look for:
QE hints: With every lackluster bit of data that arrives, pressure builds on the central bank to launch a full-scale quantitative-easing program. But few economists expect ECB President Draghi to pull out the “big bazooka” just yet. Interest rates appear to have hit their bottom limit, so another rate cut is also widely ruled out on Thursday.
“While the pressure on the ECB to use outright quantitative easing in public assets is increasing, it is still premature to take this step, in our view,” analysts at Danske Bank said in a note Thursday. “Instead, we believe Draghi will continue to strike a very dovish tone [on Thursday] and reiterate that the ECB is ready to use QE if necessary.”
ABS purchases: The ECB will unveil more details of its “private” QE program at the news conference following the rate announcement, most analysts believe. That upcoming program — which entails purchases of asset-backed securities and covered bonds — was announced at the bank’s last meeting, in September.
“The three main questions are: what credit ratings will it require, what kind of underlying collateral will it accept, and how much it will buy (although Vice President Constancio has said that they will not reveal a precise figure),” Marshall Gittler, head of global FX strategy at IronFX, said in a note ahead of the meeting.
The new measures, coupled with a targeted long-term refinancing operation, are expected to move the ECB’s balance sheet “towards the dimensions it used to have at the beginning of 2012,” Draghi has said.
In early 2012, the balance sheet topped 3 trillion euros ($3.8 trillion); that compares with around €2 trillion in September. Read: ECB to unveil details of plan to save eurozone
TLTRO: Questions on the first round of TLTRO are also expected at the news conference. For the allotment in mid-September, eurozone banks borrowed “only” €82.6 billion, seen by market participants as a disappointment and as pushing the ECB closer toward fully-fledged QE.
The October ECB rate decision is due at 12:45 p.m. London time, or 7:45 a.m. Eastern Time, followed by Draghi’s monthly news conference in Naples 45 minutes later. No rate cuts are expected, after the ECB took its refinancing rate down to 0.05% at its last meeting. At the same time, it pulled its deposit rate further into negative territory, to negative 0.2% — a level Draghi described as “the lower bound.”
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European Central Bank makes no changes to rates
The European Central Bank on Thursday made no changes to interest rates, as expected, at its monthly policy meeting. The bank's main lending rate stands at 0.05%, while the interest rate paid on deposits parked overnight at the ECB was held at -0.2%. The interest rate on the ECB's marginal lending facility remains at 0.3%. Investors will focus on ECB President Mario Draghi's monthly news conference in Naples, Italy, scheduled to begin at 2:30 p.m. local time, or 8:30 a.m. Eastern.
ECB chief Draghi’s statement at October press conference
Ladies and gentlemen, the Vice-President and I are very pleased to welcome you to our press conference. I would like to thank Governor Visco for his kind hospitality and express our special gratitude to his staff for the excellent organisation of today’s meeting of the Governing Council. We will now report on the outcome of our meeting.
Based on our regular economic and monetary analyses, and in line with our forward guidance, we decided to keep the key ECB interest rates unchanged. Following up on the decisions of 4 September 2014, we also decided on the key operational details of both the asset-backed securities purchase programme and the new covered bond purchase programme.
This will allow us to start purchasing covered bonds and asset-backed securities (ABSs) in the fourth quarter of 2014, starting with covered bonds in the second half of October. The programmes will last for at least two years. Together with the series of targeted longer-term refinancing operations to be conducted until June 2016, these purchases will have a sizeable impact on our balance sheet.
The new measures will support specific market segments that play a key role in the financing of the economy. They will thereby further enhance the functioning of the monetary policy transmission mechanism, facilitate credit provision to the broad economy and generate positive spillovers to other markets. Taking into account the overall subdued outlook for inflation, the weakening in the euro area’s growth momentum over the recent past and the continued subdued monetary and credit dynamics, our asset purchases should ease the monetary policy stance more broadly. They should also strengthen our forward guidance on the key ECB interest rates and reinforce the fact that there are significant and increasing differences in the monetary policy cycle between major advanced economies.
Together with the monetary accommodation already in place, the determined implementation of the new measures will underpin the firm anchoring of medium to long-term inflation expectations, in line with our aim of maintaining inflation rates below, but close to, 2%. As all our measures work their way through to the economy they will contribute to a return of inflation rates to levels closer to our aim. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate.
A separate press release will provide further information on the modalities of our new purchase programmes for ABSs and covered bonds. It will be released at 3.30 p.m.
Let me now explain our assessment in greater detail, starting with the economic analysis. Following four quarters of moderate expansion, euro area real GDP remained unchanged between the first and second quarter of this year. Survey data available up to September confirm the weakening in the euro area’s growth momentum, while remaining consistent with a modest economic expansion in the second half of the year. Looking ahead to 2015, the outlook for a moderate recovery in the euro area remains in place, but the main factors and assumptions shaping this assessment need to be monitored closely. Domestic demand should be supported by our monetary policy measures, the ongoing improvements in financial conditions, the progress made in fiscal consolidation and structural reforms, and lower energy prices supporting real disposable income. Furthermore, demand for exports should benefit from the global recovery. At the same time, the recovery is likely to continue to be dampened by high unemployment, sizeable unutilised capacity, continued negative bank loan growth to the private sector, and the necessary balance sheet adjustments in the public and private sectors.
The risks surrounding the economic outlook for the euro area remain on the downside. In particular, the recent weakening in the euro area’s growth momentum, alongside heightened geopolitical risks, could dampen confidence and, in particular, private investment. In addition, insufficient progress in structural reforms in euro area countries constitutes a key downward risk to the economic outlook.
According to Eurostat’s flash estimate, euro area annual HICP inflation was 0.3% in September 2014, after 0.4% in August. Compared with the previous month, this reflects a stronger decline in energy prices and somewhat lower price increases in most other components of the HICP. On the basis of current information, annual HICP inflation is expected to remain at low levels over the coming months, before increasing gradually during 2015 and 2016.
The Governing Council will continue to closely monitor the risks to the outlook for price developments over the medium term. In this context, we will focus in particular on the possible repercussions of dampened growth dynamics, geopolitical developments, exchange rate developments and the pass-through of our monetary policy measures.
Turning to the monetary analysis, data for August 2014 continue to point to subdued underlying growth in broad money (M3), with the annual growth rate increasing moderately to 2.0% in August, after 1.8% in July. Annual growth in M3 continues to be supported by its most liquid components, with the narrow monetary aggregate M1 growing at an annual rate of 5.8% in August.
The annual rate of change of loans to non-financial corporations (adjusted for loan sales and securitisation) remained negative at -2.0% in August, after -2.2% in the previous month. On average over recent months, net redemptions have moderated from the historically high levels recorded a year ago. Lending to non-financial corporations continues to reflect the lagged relationship with the business cycle, credit risk, credit supply factors and the ongoing adjustment of financial and non-financial sector balance sheets. The annual growth rate of loans to households (adjusted for loan sales and securitisation) was 0.5% in August, broadly unchanged since the beginning of 2013.
Against the background of weak credit growth, the ECB is now close to finalising the comprehensive assessment of banks’ balance sheets, which is of key importance to overcome credit supply constraints.
To sum up, a cross-check of the outcome of the economic analysis with the signals coming from the monetary analysis confirms the recent decisions taken by the Governing Council to provide further monetary policy accommodation and to support lending to the real economy.
Monetary policy is focused on maintaining price stability over the medium term and its accommodative stance contributes to supporting economic activity. However, in order to strengthen investment activity, job creation and potential growth, other policy areas need to contribute decisively. In particular, the legislation and implementation of structural reforms clearly need to gain momentum in several countries. This applies to product and labour markets as well as to actions to improve the business environment for firms. As regards fiscal policies, euro area countries should not unravel the progress already made and should proceed in line with the rules of the Stability and Growth Pact. This should be reflected in the draft budgetary plans for 2015 that governments will now deliver, in which they will address the relevant country-specific recommendations. The Pact should remain the anchor for confidence in sustainable public finances, and the existing flexibility within the rules should allow governments to address the budgetary costs of major structural reforms, to support demand and to achieve a more growth-friendly composition of fiscal policies. A full and consistent implementation of the euro area’s existing fiscal and macroeconomic surveillance framework is key to bringing down high public debt ratios, to raising potential growth and to increasing the euro area’s resilience to shocks.
Euro Jumps Most Since May as ECB Plan Lacks Details
The euro rose the most since May as the European Central Bank failed to provide details on the size of a plan to buy private securities, curbing bets it would expand the ECB’s balance sheet enough to weaken the currency.
The yen advanced as Japanese Vice Finance Minister Nobuhide Minorikawa said weakness in the currency is hurting some companies by driving up energy prices. Australia’s dollar rebounded from an eight-month low, while the pound fell for a seventh day and the U.S. currency declined. ECB President Mario Draghi unveiled plans to buy covered bonds and asset-backed securities for at least two years.
“Draghi was playing down the oncoming rise in balance sheet, that’s the market’s initial read,” said Alan Ruskin, global head of Deutsche Bank AG’s Group of 10 foreign exchange in New York. “But over time the market will come to realize the inflation expectation will remain stubbornly inert and it’ll evoke what he said at least three times: he’s open to additional measures beyond what they’ve done.”
The euro jumped as much as 0.6 percent, the biggest intraday increase since May 8, to $1.2692 before trading at $1.2659 at 12:20 p.m. New York time, up 0.3 percent. It touched $1.2571 on Sept. 30, the lowest level since September 2012.
The yen climbed 0.7 percent to 108.17 per dollar, after reaching 110.09 yesterday, the weakest since Aug. 25, 2008. The Japanese currency gained 0.4 percent to 136.92 per euro.
The ECB balance sheet is “only an instrument,” Draghi told reporters in Naples today. The only mandate policy makers have to comply with is to bring inflation back to a level that is close to, but below, 2 percent, he said.
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