Euro Zone: Is the Light at the End of the Tunnel in Sight?

In its most recent rate statement, the European Central Bank (ECB) decided to sit on its hands and keep interest rates untouched at 0.50%. No surprises there – the markets were widely expecting the central bank to keep monetary policy as is. However, ECB President Mario Draghi did manage to shock the markets with his optimistic tone in the press con.

ECB grows more optimistic

Because of a poor start to the year which saw the economy contract by 0.2% in the first quarter, the ECB was forced to downgrade its 2013 growth estimates from its previous forecast of -0.5% to just -0.6%. But in spite of this downward revision, Mario Draghi and his men are feeling more optimistic about the euro zone’s future.

Draghi spent a good chunk of his time discussing the region’s recent developments, citing improved business and consumer sentiment. Apparently, policymakers believe that the economy is finally about to rebound from its prolonged recession. That’s right, folks! The recovery talks have begun for the euro zone!

According to Draghi, the recovery should pick up steam in the second half of the year. And by the ECB’s forecasts, the region should be posting growth of 1.1% by 2014, which is an upgrade from its prior estimate of 1.0%.

While the prospect of negative deposit rates and other easing measures were mentioned, Draghi made it clear that the ECB sees “no reason to act at this point.” Even with the lower growth forecast for 2013, the members of the Governing Council of the ECB agree that there hasn’t been a material change in the region’s economic situation to warrant action at the moment.

EUR/USD reaction

So how did the markets react? Well, as you can imagine, they went nuts for the euro!

The rate statement itself didn’t earn much of a reaction, but the press con was a whole different story. It sparked a massive rally on EUR/USD that was aggravated later in the New York session by broad-based USD weakness.

EUR/USD Chart

I guess what we can take away from all of this is that the ECB is starting to see the light at the end of the tunnel. Sure, European policymakers have played with the idea of lowering deposit rates to negative levels and buying asset-backed securities.

But their newfound optimism for the economy suggests that further easing is off the table for now… especially since it has only been a month since the ECB decided to slash interest rates to a record low of 0.50%!

The bottom line is that the ECB will need to see further deterioration in the economy before it seriously considers additional stimulus again… and that should give the markets one less reason to sell the euro.