"Not Doing Anything Next Month Would Completely Shatter The ECB’s Credibility"
This was the greatest range in a long time. It will be interesting to see when people realize that ECB did again what they were doing all the time : just talk, no action
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Mario Draghi has gone and done it.
After nearly two years of playing the market like a fiddle with nothing more than verbal intervention, Draghi was finally cornered today when during the ECB press conference earlier he explicitly stated that "the Council is comfortable with acting in June." Just that statement alone was enough to push the EURUSD lower by 150 pips from just shy of 1.40 to 1.3850.
However, this may end up being a pyrrhic victory: the reason is that until now ECB was the only central bank for which forward guidance had worked following the spectacular failure of future "thresholds" both in the US and the UK, and where central bankers are scrambling to preserve the credibility of doing nothing even though their previous fed-hike employment targets have been trampled (as we predicted in December would happen). Of course the only real threshold central bankers have is to push their respective stock markets to unseen heights and pray, but that's a topic for a different day.
Going back to Draghi, the reason why traders decided to take the former Goldman banker on his word is because what he did today was finally push the recurring bluff the ECB has used time and again one step too far.
Having done nothing far too long in the face creeping deflation and an absolute collapse in record low private loan creation, today's gambit was for Mario crossing the one bridge he can't uncross. Because as Deutsche Bank notes, "not doing anything next month would in our view completely shatter the ECB’s credibility, and trigger a further appreciation in the euro exchange rate." Or, said otherwise, the time when Mario Draghi could manipulate markets with merely a smirk, a smile and a promise to do something in the indefinite future, just ended with the whimper of EURUSD longs.
From this point the market will demand real action from Draghi, which also means that any utility the ECB's forward guidance may have had until now was just destroyed as well, since absent action the ECB will indeed have, as DB notes, zero credibility.
As such, now that he has been forced out of his "jawboning comfort zone", the ECB may as well go ahead and slip merely rate cuts, and go the full QE hog, considering that in Japan the BOJ is unable to boost its own QE now that "non-core" and imported energy and food inflation is off the charts, while the Fed is on pace to end tapering by December. And the last thing this centrally-planned world knows how to do five years after the Lehman and the recession "ended" is discover prices efficiently without central banks injecting trillions in liquidity every year and not so invisibly propping the entire market to record highs.
Below is the full take by Deutsche Bank's Gilles Moec and Mark Wall
ECB: Compounded verbal intervention
Last month’s more dovish than expected statement had left the ECB with the usual legacy problem of verbal intervention: left unchanged, and unsupported by actual decision, the strength of the message erodes very quickly, which means that Draghi needs to up the ante every time just to keep the market on his side. This is how we interpret today’s performance. While the prepared statement was virtually unchanged, Draghi’s Q&A was full of dovish nuggets such as “the Council is comfortable with acting in June”, or “the euro exchange rate is a serious concern”. Now that the June meeting is explicitly going to be crucial, not doing anything next month would in our view completely shatter the ECB’s credibility, and trigger a further appreciation in the euro exchange rate. We were expecting a move in June anyway. Today’s press conference strengthens this view. However, we are expecting a small move only – to be precise an extension in full allotment to nail the “decoupling from Fed” theme home. True, after today, odds for more decisive conventional action – negative deposit rate is an obvious candidate – are higher, but we think that two conditions would need to be met for the ECB to cross that Rubicon: some material change in the ECB’s economic outlook and/or further appreciation in the euro.
June confirmed as the crucial moment
Calling, as Draghi did this afternoon, today’s Council meeting a mere “preview” of the June meeting, and stating that “the council is comfortable with acting in June” probably reflects a series of three concerns. First, the central bank probably wants to create a tight relationship between the timing of inflation forecasts and actual policy decisions. In retrospect, the central bank may have come to the conclusion that it had made a mistake when issuing a very subdued inflation forecast in March without accompanying it with either action or a substantial dovish turn in communication (the latter came in April only). As the ECB, in our view, will have to revise its inflation forecast down in June, at least for 2014, given the lower starting point, it makes sense to keep some dry powder. This is also
consistent with Draghi’s comment that the ECB could consider fewer monthly meetings.
Second, we think that there could be here another episode of Draghi’s habit to create a “fait accompli” configuration which forces the hand of the Council. Indeed, we think that the Q&A – very much controlled by Draghi alone – was significantly more dovish in tone than the prepared statement. We knew last month was the Council was “unanimous” on its commitment to contemplate “all instruments”, but after extracting an important concession on the “what” in April, Draghi may have cornered the Council into the “when”. Third, the recent data and news flow is erratic. That is particularly true of the inflation numbers given the Easter disturbance mentioned by Draghi. The print for May – which will be the first “pure” reading – will matter. The Ukraine crisis (geopolitical issues have been upgraded in the ranking of the downside risks to the economic outlook) adds another layer of uncertainty. Draghi also mentioned the need to take a hard look at credit developments “in the next few weeks and the next few months”, as the central bank is probably increasingly frustrated by the continuing contrast between fairly positive surveys on lending behavior and still poor loan origination. There again, the next batch of monetary statistics could help the ECB to decide.
We find it quite interesting that Draghi today told us that the ECB is “dissatisfied” with the current trajectory for inflation, and “not resigned” to a low inflation regime (two more dovish nuggets). Well, since their forecasts in March already pointed to “protracted low inflation”, this may beget the question of why then did they not act already. However, there probably still are internal hesitations around the right instruments to use, and this, rather than a debate on the actual diagnostic on the deflation risks, may actually explain why the ECB has not acted sooner.
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