ECB: Opening Doors for More Easing

As expected, the European Central Bank (ECB) refrained from cutting interest rates at its latest meeting. Instead, ECB officials decided to keep rates steady at 1.00%, while continuing to offer unlimited loans to those who ask.

In his accompanying statement, ECB President Mario Draghi even downplayed the severity of the European crisis, basically saying, “Yo homies, we ain’t nowhere near Lehman levels. So chill out and have a pizza.”

The ECB also barely made any revisions to its GDP and inflation forecasts. 2012 GDP projections remained the same at between -0.5% and 0.3%, while 2013 GDP estimates were revised lower from 0.0%-2.2% down to 0.0%-2.0%.

Meanwhile, the expected range for inflation for 2012 was tightened from 2.1%-2.7% to 2.3%-2.5%, while the forecasted band for 2013 is now seen to be at 1.2%-2.2% (as opposed to earlier forecasts of 0.9%-2.3%).

The ECB’s stance wasn’t too surprising, as it obviously wanted to keep markets calm and refrain from stirring up any more fears of economic doom.

Still, the ECB did keep its doors open for more easing down the road.

In fact, Draghi hinted that some ECB members may have preferred a rate cut as early as this month. However, they decided to delay and wait for more developments with regards to Spanish bank recapitalization and the upcoming Greek elections.

In case the ECB does decide to act, its best weapon of choice may be to go with an interest rate cut.

For one, Draghi has expressed some concern with how much more effective an expansion of the ECB’s LTRO program would be.

Secondly, if the ECB were to purchase more bonds, it would be pushing the limits of its powers and would give the impression that it is indeed becoming a “lender of last resort.” Draghi even said that monetary policy should not be used to fill the void caused by the lack of action by other institutions. Draghi was basically calling out euro zone governments to do their part before the ECB steps in!

EUR/USD Chart

In any case, the market’s initial reaction was to sell the euro. EUR/USD fell to as low as 1.2450, but it soon erased its losses and rallied sharply up the charts to forge a new intraday high.

I suspect it took the markets a while to digest what was said and realize that the central basically hinted that it would be open to more accommodative policies. After all, the newswires went abuzz with rumors that we could see more stimulus from the ECB not long after it made its rate decision.

Looking ahead, I think there’s a chance that we’ll see a return of risk appetite and an extension of the euro’s rally in the coming days. Central banks all around the world – including the ECB and the Fed – have been showing greater willingness to ease monetary policy.

It’s actually quite weird if you really think about it. Usually, the prospect of more easing leads to currency depreciation. But that isn’t the case right now, as markets have been trading on risk sentiment in recent weeks. As such, any news of the “prospect of growth” has been boosting higher-yielding currencies.

For now, I think the wise thing to do would be to listen closely to all interest rate decisions, as central bankers’ words could dictate forex flows over the next few weeks… or even months!

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