Mario Draghi and the ECB’s governing council voted today to keep rates unchanged, although a cut was suggested by some members.
Last month’s dramatic pivot to a dovish monetary tone that interest rates should remain “at present OR lower levels for an extended period of time” was reiterated again today in remarks that monetary policy will remain accommodative for “as long as is necessary”. Draghi described an economy that is “weak, fragile, and uneven” and left the prospect of issuing another LTRO on the table. We expect that given the continued clog in the credit channel, a liquidity package could be released into year-end (see chart below).
Interestingly, and despite the dovish commentary, the EUR/USD rose following the announcement, which we think is reflective of the impact of Bernanke talking down U.S. growth prospects (and the USD), as well as the Eurozone economy showing improvement on the margin.
As central bankers struggle to guide expectations (hint Fed’s no-taper decision and the ECB’s and BOE’s forward guidance) we wouldn’t be surprised to see Draghi keep his cards tight on when he may issue liquidity measures or cut rates, and continue to drag his feet on any policy action until more data confirms his team’s outlook.
As it relates to the Eurozone, our call remains that we expect Europe’s economy to gradually improve off low levels (we’re UK and German equity bulls) and bullish on the EUR/USD, which is in a bullish breakout above its TRADE, TREND, and TAIL levels (see chart below).
Draghi highlights from the Press Conference:
- Somewhat weaker growth in the beginning of Q3, but still expects a gradual recovery
- The recovery is “weak, fragile, and uneven” and starting from very low levels
- Unemployment, especially youth, needs to be reduced from very high levels
- Credit dynamics remain subdued with flows “still weak, very weak”
- On broader developments of liquidity: ECB is ready to use all available instruments, including LTRO
- Inflation continues to be firmly anchored, on the very low side of the 2% target (at 1.1%), but the baseline scenario has been underpinned
- Progress is being made on political reforms: greatest pressure should come from the inside; don’t need to be pressed by markets
- On political instability (Italy and the rise of anti-Euro parties in Germany and Austria): while instability hampers hopes for a recovery, it doesn’t hurt the foundations of the Eurozone as it used to do a few years ago -- that suggests that the Eurozone and Euro is more stable