Euro slides sharply as Draghi suggests ECB ready to ease
12/May/2014 • Currency Updates•
The early half of the week saw more of the sluggish currency trading we have been experiencing lately; tight ranges and lack of a clear trend. All this changed suddenly during President Draghi’s press conference after the European Central Bank May meeting. Draghi stated that the council was very concerned with Eurozone inflation, which remains far below the ECB target; he added that the Council was unanimous in favour of taking action at its next meeting in June, which formally buries his predecessor’s policy of “never pre-committing”. The euro fell by nearly one percent within minutes of these statements, and continued to slide for the remainder of the week against all other major currencies. Significantly, sterling largely held its own against the dollar immediately after Draghi’s comments, in a sign that markets are becoming more comfortable with a decoupling between the Bank of England’s monetary policy and that of the ECB, as the UK economy continues to outperform the Eurozone’s.
A spate of positive data out last week continued to point to above trend 3-4% growth in the second quarter. The PMI measure of business confidence for the service sector rose to a four-month high of 58.7, consistent with strong growth in the sector. The April Markit jobs report showed clear signs of acceleration both in hiring and pay increases. Even the external sector is joining in, as the March trade report showed exports rising by 5.9% MoM, while imports remained more subdued, growing just 3.2%. The Inflation Report will give a critical read on how the Bank of England will react to the economic acceleration. Of particular importance is whether the MPC will validate the market’s view that the first hike is likely to come in the first quarter of 2015, rather than the second quarter as implied in the previous Inflation Report from February.
The shocker delivered by Draghi on Thursday overshadowed all other economic news. His comments were unusually blunt and appear to mark an inflection point in ECB communication policy, as well as a more general shift towards increased activism and more aggressive assumption of its responsibilities. According to Draghi, the Council was “dissatisfied about the projected path of inflation” and there was a “consensus about not being resigned to this and in favour of policy action in June”. In our latest weekly (which can be seen here ) we went out on a limb and stated that there was a 50% chance of a cut in rates at the June meeting. Now however, we do not see how the ECB can disappoint the expectations that it created at today’s press conference. Therefore, we now think that rates will be cut at the June meeting by 0.25%. Further, we expect material steps towards further direct ECB intervention in financial markets. This includes both quantitative easing by buying sovereign and private debt, as well as initiatives targeted towards SMEs.
The strong rebound in leading indicators of economic activity so far in April and May makes us confident that the US economy will rebound strongly from the weather-impacted slowdown seen in the first quarter. In addition to the very pleasant labour market surprise the previous Friday, we have seen the business confidence surveys and retail sales report outpace expectations. Last but not least, weekly jobless claims continue to trend downwards. We are particularly fond of this often overlooked indicator, which despite its volatility provides the best high-frequency read on the health of the US economy. We continue to expect a print somewhere near 3.5% in second-quarter growth, and a $10 billion “taper” at each FOMC meeting until the monthly purchases are eliminated altogether in the December meeting.