Financial markets are intently focused on what central bankers say. In the wake of the European Central Bank’s much-anticipated meeting on Thursday, it was what president Mario Draghi failed to say that captured most attention.
With most investors and traders expecting the ECB to leave an announcement on its tapering plans to October’s meeting, the build-up to Thursday’s gathering had been dominated by whether the ECB — or Mr Draghi at his press conference — would voice any disquiet at a rally in the euro that has pushed the single currency to its highest level against the dollar since early-2015.
While the ECB president referred several times to the euro’s strength, saying euro volatility “represents a source of uncertainty”, it didn’t dent the euro. The market’s reaction consisted of driving the single currency higher and above $1.20.
That was marginally below the $1.2069 that the euro touched on Friday. As the euro climbed, bond yields fell and eurozone equities remained in positive territory, but off their highs touched earlier in the day.
“Draghi’s attempts to highlight and talk around the euro’s strength have only had the effect of pushing it higher,” says State Street’s Tim Graf. Analysts at Rabobank say his comments on the euro lacked conviction and investors believe the ECB has no choice but to eventually phase out asset purchases.
A rising euro has been a headwind for European equity markets since they peaked for the year in early-May, as it represents a tightening of financial conditions, keeps inflation expectations subdued and hurts exporters.
That was referenced by Mr Draghi during his press conference as he made the point that a stronger currency may damage exports while ECB staff projections for inflation and growth assumed a euro value of $1.18.
“I don’t know where the euro is right now. I am told it’s at $1.20,” he said, to some incredulity in the press conference at Frankfurt. But he said the exchange rate was not a policy target.
According to Adrian Hilton at Columbia Threadneedle, the ECB president’s tone was “more relaxed than many had expected, suggesting that he views the euro’s appreciation as reflective of improved economic fundamentals”.
The present level does not threaten the ECB’s medium-term inflation objective, Mr Hilton adds.
However, a problem will come if the euro pushes towards $1.25, which would see the ECB “trapped between a disinflationary exchange rate and a need to phase out its QE purchases before it runs out of bonds to buy”.
While the ECB increased its GDP forecast to 2.2 per cent for 2017, which would be the fastest pace in a decade, it clipped next year’s inflation forecast to 1.2 per cent.
According to Nomura, the modest nature of the inflation revisions, combined with upward revisions to the growth outlook, “suggests that the ECB is on course to announce a tapering programme in October”.
The governing council had begun preliminary discussions on how to scale back its asset purchase programme, Mr Draghi said, with the bulk of decisions expected next month, though he was careful to stress that all options remained open.
ING said the ECB’s euro concerns pointed to a high probability of a dovish form of tapering being announced next month while Neil Mellor at BNY Mellon says the most consistent driver of the currency had proved to be shifting expectations about the ECB’s QE programme.
The bottom line for Luigi Speranza at BNP Paribas was that, while the ECB was more dovish than expected, particularly over the euro, the central bank “effectively formally opened a debate on the exit”, and loosely committed to an announcement next month.
“Implicitly, the bias is to reduce the pace of asset purchases somewhat, even though this is now heavily conditional on developments in the FX markets,” says Mr Speranza.
Mr Draghi’s remarks conveyed a sense that the eventual retreat from QE will be very slow and prolonged.
Anna Stupnytska, global economist at Fidelity International, says: “I continue to believe that the ECB will continue its very gradual approach to withdrawal of policy accommodation with QE tapering likely to run throughout 2018.
“With or without euro strength, other more fundamental factors such as low wage growth and underlying structural issues are likely to prevent the ECB from exiting unconventional policy measures quickly and cleanly.”