ECB brings out the big guns, but FX market shrugs
09/Jun/2014 • Currency Updates•
The financial week was dominated by the drama surrounding the European Central Bank meeting on Thursday. President Draghi did not disappoint, and went further than most commentators had expected in the ECB’s new raft of easing measures. Surprisingly, after a brief dip, the euro bounced right back and managed to end the week slightly higher against both sterling and the dollar. It seems that positioning (the IMM report had speculators short the euro and long record amounts of sterling contracts) trumped the ECB surprise, turning the event into another example of “buy the rumour, sell the news”. However, with the ECB in full-on easing mode, while the Bank of England and the Federal Reserve begin to look at the timetable for hikes, we think the euro will struggle to rally over the medium term.
The PMI business sentiment indicators remained at a very high level in May. They continue to hover at levels clearly above trend, consistent with economic growth in the 3-4% range. However, the Bank of England surely welcomed news of another decline in April mortgage approvals, a sign that ultra-low rates are not causing an undue bubble in the housing market. Overall, we agree with the interest rate market in pricing in a very cautious rate cycle starting in the first half of 2015, and continue to see sterling well supported against the euro.
As we expected, the ECB surprised markets announcing a set of measures that go beyond what most commentators had pencilled in. The main refinancing rate was cut to 0.15 from 0.25. The deposit rate, where banks park their excess reserves, was also cut 0.10, to -0.1 (we expected -0.25). The ECB also launched what it calls Targeted Long Term Refinancing Operations (TLTROs) modelled after the Bank of England’s Fund for Lending Scheme, with a total of 400 billion euros and 4 year duration, focused on lending to non-financial Eurozone corporations. Staff inflation forecasts were revised significantly lower. The inflation forecasts for 2014, 2015 and 2016 were lowered by 0.3, 0.2 and 0.2 to 0.7, 1.1 and 1.5. Perhaps most significantly, Mario Draghi made one of his signature meaningful statements, stating “We are not finished here”.
These welcome measures could not have come a day sooner. Eurozone May inflation surprised, yet again, to the downside, with a nasty 0.5% print, down from 0.7% in April and by far the lowest of any major currency area. We agree with Mr. Draghi that the ECB is far from finished and we expect further action as early as the September meeting, in keeping with the institution reluctance to undertake major initiatives during the summer months.
Friday payrolls report was somewhat overshadowed by the ECB announcement, but it was still the key development across the Atlantic. The number came out exactly in line with expectations. 217,000 net jobs were created in May, and the numbers for the previous months were essentially untouched. This is the fourth consecutive print above the 200,000 level. Furthermore, total labour incomes are rising now at an annualised rate of 5.7% (the combined result of decent job growth and very moderate wage gains). We think a continuation of this level of job growth will become incompatible with 0% rates in early 2015, and expect the Federal Reserve to lead the Bank of England in hiking rates – though not by much.