ECB: The Euro, and a September Stop

Published on January 25, 2018

All eyes were on President Mario Draghi at today’s European Central Bank Governing Council meeting, looking for a response to repeated recent remarks made by US Treasury Secretary Steve Mnuchin praising the benefits of a weak dollar, remarks that sent an already buoyant Euro soaring even higher.

Draghi pulled no punches in expressing his displeasure at Mnuchin – but the Euro rose nevertheless. And we believe it will continue to rise.

*** Beyond the currency jawboning on both sides – ECB officials having already come out in full force even before Mnuchin’s comments to complain about “volatility” in the Euro currency – Draghi did nothing but confirm the market’s assessment of the clear, powerful momentum behind the Eurozone growth and recovery.  We believe there is a very strong chance as things stand the ECB will revise upwards its growth forecast at its upcoming March quarterly ECB Staff Macroeconomic Projections review. ***

*** And furthermore, on the policy side, even while attempting to present a neutral and cautious summary of the policy choices the ECB will be facing on QE this year, President Draghi let drop numerous hints that to us affirm, as we first flagged earlier this month, that the growing consensus within the ECB Board and Governing Council is to bring QE to a hard stop once the current program runs out this coming September (see SGH 1/10/18, “ECB: The Beginning of the End of QE”). ***

Draghi’s Two “Tells”

Draghi laid out three (really, two) options the ECB would be deciding between when the current QE program runs out this year: extend the 30 billion Euro/month purchase program again (zero chance); halt new purchases after September, or; taper purchases down to zero, presumably over the last three months of the year.

While non-committal between any of these options – certainly an appropriate position given where we are in the calendar year – Draghi however also in effect provided two subtle “tells” in where the debate is headed: first in alluding to the importance of reinvestments when considering the policy actions and degree of accommodation the central bank is injecting into the system, and second, in pointing to the importance in measuring the “stock” of the central bank asset purchases rather than the “flow” in his analysis.

These are two clear arguments for why ending monthly purchases should not be seen as an end to accommodation – and both are borrowed heavily from the lexicon of the Federal Reserve when it too was looking to communicate an end to its QE program. And while perhaps subtle, we believe they mark a kick off to a communication process of preparing the groundwork for an end to QE that we still believe will come in September.

On rates policy, however, Draghi clearly pushed back on the notion of a hike this year, anchoring, as we pointed out in the January 10 report, the very front end of the curve with the commitment to keep rates on hold “well past” the end of the purchase program.

And on the all-important inflation numbers, Draghi also confirmed the ECB expectations that even while the headline rate might be contained for some time due to year-on-year energy price base effect, the most important core, or “underlying,” inflation is indeed still expected to rise.

We expect the ECB will use the March quarterly meeting and what will be upwardly revised forecasts by then to lay the groundwork for changes to the guidance, and to flag the likelihood of an active discussion of the QE program’s fate by June. That will of course all have to be settled by the program end-date in September.

In the meantime, Draghi and crew may have to rely on other “exogenous” forces to counter the Euro strength that is being driven by the US Treasury Secretary, Eurozone fundamentals, policy expectations, and the overall continued “risk-on” flow of funds from the US to the Eurozone, EM, and global markets at large. Perhaps that will come from the Federal Reserve.

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