“Super Mario” Draghi strikes again! In his presser yesterday, the European Central Bank (ECB) head honcho boosted the euro with his remarks. Thing is, he actually meant to be dovish. What’s up with that?!
Here are key takeaways you need to know from the ECB’s July policy decision and Draghi’s presser that followed:
No changes to policies AND forward guidance
As mentioned in this week’s ECB trading guide, market geeks weren’t expecting any policy changes from the central bank. However, they did expect Draghi and his gang to start laying the groundwork for possibly reducing their asset purchases down the road.
Instead, the ECB decided to keep its policies AND forward guidance unchanged for another month. Main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively.
Meanwhile, asset purchases will remain at €60B “until the end of December 2017, or beyond, if necessary.” The ECB added that “the Governing Council stands ready to increase the programme in terms of size and/or duration” if the outlook becomes “less favourable.”
In his presser, Draghi explained that he and his team have “confirmed the need for a continued very substantial degree of monetary accommodation” after looking at inflation and “signals” from their monetary analyses.
This is why they’ve taken the “prudent” road and decided (unanimously) not to make changes to their forward guidance AND not to set “precise dates for when to discuss changes in the future.” However, Draghi did hint that they would hold their more serious discussions “in the autumn.” But more on that later.
Strong growth, weak inflation
Draghi echoed sentiments of other major central banks when he lauded the euro region’s economic growth prospects but downplayed its inflation outlook.
The ECB head honcho pointed out that data (especially survey results) “point to solid, broad-based growth” while global recovery is supporting euro area exports. Slow structural reforms dampen its prospects though.
Overall, the ECB thinks growth risks are “broadly balanced,” with “positive cyclical momentum” balancing out the downside risks involving “global factors.”
Draghi wasn’t as optimistic on inflation. Basically, ECB members believe that “inflation is not where we want it to be, and where it should be.”
Draghi started by saying that
“While the ongoing economic expansion provides confidence that inflation will gradually head to levels in line with our inflation aim, it has yet to translate into stronger inflation dynamics.”
He added that headline inflation is weighed down by lower energy prices, and that underlying inflation has yet to show “convincing signs of a pick-up.” If you recall, the euro zone’s HICP clocked in at 1.3% in June, which is way below the ECB’s 2.0% target.
Hawkishness was misinterpreted
Back in late June, Draghi rocked the markets when he talked about a “strengthening and broadening economy” in the same speech where he said that “deflationary forces have been replaced by reflationary ones.”
This led market players to believe that the ECB is willing to look past the Euro Zone’s weak inflation and maybe start to wind down its QE program. Fast forward to this week and a hundred or so pips for the euro later and Draghi is now saying that market players might have overreacted a smidge.
He clarified that, in his speeches in Sintra and in Tallinn, he was really talking about the Governing Council’s confidence that their policies will lead to economic recovery:
“All this says basically that the ECB, the Governing Council – first of all – trusts the strength and the power of its monetary package in all its elements.
Second, it says that the Governing Council is ready to use the flexibility that is needed to make true its monetary policy package. And third, it says that the ECB will stay in the market for a long time.”
Draghi also downplayed the market’s reaction to “reflation,” saying that it just means recovery “from below the trend line.” At the end of the day, he said that his speeches in Portugal and in Estonia were not much different from the ECB’s cautious stance in its June policy release.
Not too worried over strong EUR?
When asked if he’s concerned about the euro’s gains since his hawkish speech in Sintra and its impact on inflation, Draghi only repeated that he won’t comment on market reactions. In fact, his only thoughts on the matter were that “the repricing of the exchange rate has received some attention.”
Draghi and his team aren’t as chill about the financial market’s reaction in general, however. He explained that “unwanted tightening of the financial conditions” is one of the reasons why they’re keeping their easing bias (emphasis mine):
“[A]fter a long time, we are finally experiencing a robust recovery, where we only have to wait for wages and prices to move towards our objective.
Now, the last thing that the Governing Council may want is actually an unwanted tightening of the financing conditions that either slows down this process or may even jeopardise it; and that’s why we retain the second bias, or let’s call it, reaction function.
“If the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase our asset purchase programme in terms of size and/or duration.”
And I think the Governing Council has given enough evidence that when flexibility is needed to achieve its objectives, it has been very able to find all that was needed. So that’s why we keep this bias.”
Autumn is coming
Who needs Winter when Autumn promises to be more exciting for traders? Out of all the things Draghi said, it seems that market players were most curious about the discussions that would happen “in the Autumn.”
When asked if the Autumn meeting will result to a change in policy stance, Draghi explained that “That’s exactly why we are having this discussion in autumn, and why we didn’t want to set a precise date; because we have to have all the available information at that point in time, which we’ll certainly have by then.”
And when asked if the discussions will include road maps or timetables of any policy changes, Draghi said that “This is exactly what is going to be the substance of our discussion in the fall. So the answer is yes, the ECB considers it useful, important, essential, and that’s the sort of discussions we’ll be having in the fall.”
He added that the discussions will be “multi-faceted,” as it will involve the path of inflation, growth recovery, and their reaction to unwanted tightening of financial conditions (if there is one).
And before you think “Autumn” means “September meeting,” Draghi has already warned that “if the Governing Council had decided to define autumn as 7 September, we probably would have said that 7 September is going to be when we’ll decide. So it’s going to be deliberately kept open.” Now you know.
EUR traders missed dovish part of the memo
Draghi made a decent effort at peppering the ECB’s optimism with dovish notes, but euro traders just didn’t care for his killjoy vibe.
Instead, all they heard from the event was that (a) ECB could still start its plans to taper QE this year and (b) Draghi isn’t too concerned over a strong currency.
As a result, the euro rocketed against its counterparts with the common currency clocking in two-year highs against the dollar and eight-month highs against the pound. Wowza!