ECB: Strongly Vigilant No More

In the interest rate announcement, ECB President Jean-Claude Trichet said that the bank had chosen to keep the bench mark interest rate at 1.25% and that there would be no rate hike before July. While the bank’s decision to maintain rates was broadly expected by the market participants, they were surprised about the ECB not hiking the rate in June.

Prior the announcement, the market had believed that Trichet would be at least slightly hawkish and would hint at a rate hike next month. As for the outlook, he indicated that it was “balanced,” but the economic environment was still full of uncertainties.

But what really got the market players going was Trichet dropping the words “strong vigilance” in his statement. Recall that in the March meeting the market went all bullish on the euro on due to big man Trichet’ s promise that the central bank would exercise strong vigilance over the rising inflation (i.e., raise rates swiftly if needed).

Minutes after the event, the euro staged a massive drop across the board, with EUR/USD falling to 1.4510 from 1.4823. If you did the math, you would’ve seen that that the pair had dropped more than 300 pips, roughly equivalent to how much the pair moves in an entire week. If you were bullish on the euro, then you probably felt what I felt when the Laker’s lost twice despite its home court advantage! Ouch!

Wait, what?

How can omitting just one word from a statement could send the euro plunging across the board? You’re saying that just because Trichet didn’t include the words “strong vigilance,” the euro dropped more than 300 pips?

Yes, that’s what I’m saying.

In the foreign exchange market, even the little things count. Let’s take a quick look at how the central bank‘s statement has progressed over the last three times and the resulting move on EUR/USD.

March April May
ECB Statement Maintained rate at 1%, but hinted at a hike the following month Increased the rate by 0.25% and said that they would be strongly vigilant over rising inflation Kept rates unchanged and dropped the words “strongly vigilant”
Resulting EUR/USD move 120-pip rise 60-pip rise 300-pip drop

What’s going to happen now?

Obviously, the earliest rate hike we could see out of the ECB will be on July. The combination of profit taking and traders pricing OUT their expectations for a rate hike next month will continue to give the euro bulls a major headache. There are probably a lot more stops on the way down, especially those of longer-term traders, which could mean more losses for the euro.

In any case, watch out inflation figures in the coming months as they will determine how hawkish the ECB will be. The ECB expects inflation to top out at around 2.5%, but if it unexpectedly surges, we could see the ECB go hawkish on interest rates again, which could lead to rally in the euro.

  • Joshua Pearce Gibson

    Greece leaving the Euro would be a fundamentally good thing, right…. Just like when the Sterling left the ERM. That went over real well.

    • Buckscoder

      What has the Sterling and UK to do with Greece? UK and Greece are completely different cases. UK is a major economy. Greece is not. In fact, Greece attended the euro zone when the euro was alread pretty high in value.

  • Xavi

    @62b7e39e79762bf0241b13dbb88c750a:disqus You said

    ” If Greece would leave the euro that would be a fundamentally go sign for the euro. If you look at the timeline at Friday, after nfp news came out the eurusd was just hoovering around 145 with even slightly uptrend. That was the time the Greece thing hit the news. Then later when they denied, the euro started dropping. So, it started dropping, because Greece is NOT leaving the euro zone. Does that makes sense?”

    No one knows what exactly can happen if Greece leaves the Euro, for example, Greece would make a haircut on its debt, hitting big some European Banks, other PIGS bond would drop further, confidence in the Euro would vanish, and In the long term, everybody knows Portugal and Ireland can’t pay their debt, chain reaction!.

    What would happen with all those €’s in Greece by the way?

    • Buckscoder

      Well, I’m talking about long term speculation. If Greece would leave the euro, all the issues with Greece would vanish for the euro zone, because then Greece hat do deal with it on their own.

      The people in Greece would still have euros. They just couldn’t get more of them as cheap as now where the taxpayers of other countries pay for them in the long run.

      At least: Greece is nothing important for the euro zone. Greece doesn’t produce many goods or is a primary economy pusher. Frankly, if Greece would have not been attended a couple of years ago, the Euro would be more valuable right now. Same thing with the other pigs.

      • Xavi

        @62b7e39e79762bf0241b13dbb88c750a:disqus
        “Well, I’m talking about long term speculation. If Greece would leave the euro, all the issues with Greece would vanish for the euro zone, because then Greece hat do deal with it on their own.”

        I think you forget France and German banks exposure to Greek Debt, is not only a problem for Greece if they leave, otherwise Euro Members would have asked the Greeks to leave already don’t you think?But I understand your point of view, only if Euro Survives Greece and maybe other PIGS leaving the Euro, then it would be a good thing, but I honestly doubt it, we’re talking about more than 2 trillion economies leaving, and yet it doesnt resolve the main problem, not so strong economies compiting with Germany and France for example.

        • Buckscoder

          Sure some banks in France and then Germany would have problems. Anyways, that is not bad for the Euro in the long run. They have the issues anyways. Sooner or later it must come to the surface. It’s the same like with the big debt in the US. If the US government wouldn’t print more and more money there would be issues now showing up, but it would anyways be good for the buck in the long run.

          Regarding your argument what would happen if all pigs would leave the euro zone with all their money: Actually, a currencies value doesn’t base on how “big” it is. Look at Switzerland. It’s a very small country, but right now it shows that it is more stable than many other so called major pairs. The franc even has more value now than the usd.

          All the pigs are more or less socialistic countries. Look at Italy for instance. When they had their Lira, an espresso would take 1000 Lira. Spain had the peseta. A coffee charged for 20-30 pesetas. And so on. While Germany had the DM and one coffee charged for maybe 1-2 DM. Those countries are simply too different with their economies to all have under one currency. That is root of the problem. Thats why there are also discussions to split Europe in a northern and southern euro zone.

  • Buckscoder

    Hawkish, hawkish, lol. I’m still buying (started after the first drop). This has nothing to do with Trichet. When you look at commodities and company shares they plunged the same day. Everything beside the dollar was in the red and that is because of sell in May and go away and not Trichet. Prices can’t go up or down straight. Ppl like to catch profits after a while. That’s the real reason for this drop. Look, the euro started this massive bull rally from a 128 in Jan and topped out at 149 after just 4 months. That’s a huge 2100 pips run without major setbacks. A setback was due! Unfortunately, there is no option for me to vote on your poll.

    The reason I see this huge drop as opportunity for going long is: The euro now has +1% ofter the usd rate and that doesn’t change in the upcoming months to the lower side. The economy in the EU is accelerating and that with high taxes means more inflation. Then, that statement at the press that Greece leaving the euro spiked more bears makes no sense. If Greece would leave the euro that would be a fundamentally go sign for the euro. If you look at the timeline at Friday, after nfp news came out the eurusd was just hoovering around 145 with even slightly uptrend. That was the time the Greece thing hit the news. Then later when they denied, the euro started dropping. So, it started dropping, because Greece is NOT leaving the euro zone. Does that makes sense?

    I’m not saying the euro can’t drop further, but I don’t see a permanently drop. This is just a temporary setback. Could take some time, though, until it will hit old highs.

    Just 2 cents from me. :)