The previous charts are pointing out to a widening spread between Germany and EU producer prices and with borrowing costs for small and medium sized company in Spain and Italy at two year low and EU CPI trending higher the hypothesis I was thinking of was that we were getting rid of an obstacle for a more expensive Euro.
It looks like further inflationary easing measure whose side effect is to depreciate the common currency are going to widen the spread between Germany and EU and therefore they are unfeasible leaving the road open to a further rise of the common currency.
Reason why for yesterday’s meeting I was expecting to see the ECB President Draghi to strike a dovish tone to reinforce the Governing Council’s forward guidance and using the “tone” for taking no action, with the ECB continuing to point to interest rates needing to remain at present levels for an extended period of time, despite the improved short-term business cycle data.
One of my focus was the ECB’s tone on money market rates and how the Council viewed the effective monetary policy stance priced.
Let’s now evaluate “the facts” and compare them to the hypothesis
- “These shoots (of recovery) are still very, very green,” Mr. Draghi said. The ECB’s rate-setting board kept its key interest rate unchanged at the record low of 0.5% and announced no new stimulus measures. Officials discussed the option of cutting interest rates Thursday but decided that the best course was to maintain the “forward guidance” they unveiled in July. Interest rates will stay at current or lower levels for “an extended period,” Mr. Draghi said.
A dovish tone has been used as expected cementing the idea that rates will stay low. In this way ECB officials hope to shield short-term interest rates in the euro zone from global volatility, including any knock-on effects of the U.S. Federal Reserve’s looming decision on asset purchases. As James Mackintosh writes on the FT:
Here is a shorter version of Mario Draghi’s explanation of the forward rate guidance from the ECB he presides over: “Don’t worry, we’ve got this”.
- ECB officials were at odds over how to interpret these trends. Some members “observed that improvements in the economy did not justify this discussion” on rates, Mr. Draghi said. “Several other governors observed that the recovery is still too green…to exclude this discussion.”
The obstacle for a more expensive Euro is still there, therefore invalidating temporary my hypothesis. Indeed the Euro traded lower versus the greenback closing the European session at 1.3125$ (Dec Futures), down 0.65% .
- On money market Mr Draghi stressed that the ECB was “particularly attentive” . Money market forward short-term interest rates, which fell after the initial guidance, have returned near the levels they were before the policy was introduced.
This was the main driver of the Euro appreciation hypothesis, but an appreciation of the common currency could hurt exporters reason why while last month he had called some of the market interest rate moves “unwarranted”, this month he suggested an interest rate cut would be justified “if money market rates were judged to be unwarranted”, therefore hammering the stronger Euro hypothesis. One step that could possibly remove temporarly another rate cut would be for the ECB to inject more liquidity into the banking system through cheap loans known as LTROs, thus proposing again the common currency appreciation hypothesis.
It’s now time to turn our attention to today’s NFPs to search piece of new informations to solve the “to taper or not to taper” dilemma.