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EURUSD closed around 1.1845 in the U.S. session Friday, edged up +0.27% on less dovish ECB hold as ECB is quite calm about the recent strength of the common currency against the US dollar as-well-as British Pound. Moreover, the ECB sounds more optimistic about the economic recovery than the market expected. And above all, growing uncertainty about a soft Brexit (with FTA) caused a plunge in GBP, made EUR stronger. EURUSD was almost flat (+0.06%), while GBPUSD soared around +3.86% for the week (ended 11th Sep).
As a recapitulation, although after the ECB presser, EURUSD was almost flat, on 1st Sep, EURUSD scaled 1.5-years high 1.2012; but it soon slid as Germany's retail sales fell unexpectedly in July, raising concerns about the recovery in Europe's largest economy. In addition, headline CPI in the Eurozone fell in August for the first time since May 2016 and the core inflation hit a record low.
Also, EUR was under stress as the ECB chief economist Lane said the exchange rate matters to monetary policy. Lane also pointed out a currency war is the last thing the world needs in a veiled reference to Trump admin (Fed) policies; policymakers need to tread carefully in forex.
As per another report, EUR appreciation has worried some ECB board members and warned further gains will weigh on exports and imported inflation. ECB policymakers said privately the recent strength in EUR is becoming a growing concern, particularly after the Fed’s dovish move last week (change in inflation targeting mechanism) and after the Eurozone’s deflation in August.
The Eurozone economy fell unexpectedly into deflation territory in August as domestic demand remained subdued due to the lingering resurgence of COVID-19. Overall, EUR jumped almost +1.38% in Aug as it was supported by broad weakness in the greenback amid U.S. political stalemate over corona stimulus 4.0 and Fed’s virtual commitment of no rate hikes till the unemployment rate falls towards 4% and average US core PCE inflation stays above 2% for some months. As neither of these two Fed goals will be achieved in the foreseeable future, the Fed may hold the rate at current levels (0-0.25%) through 2021-22.
But at the same time, the ECB has also no plan for any rate hikes either till 2022 or even forever! The real reason behind EUR’ surge may be the coronavirus carnage is far deeper in the U.S. than the EU and relatively much better fiscal space in the EU to fight the corona recession.
In any way, the market was expecting Lagarde to sound like her predecessor Draghi (‘whatever it may require’) to boost inflation & growth. But in the presser, Lagarde was less dovish than expected and didn’t attempt to fire an immediate bazooka. Although no major changes in the current policy stance were expected from the ECB in June, the market was also expecting that Lagarde may try to talk down the EUR by hinting of more QE amid the deflationary trend. Lagarde was also expected to counter his Fed peer Powell’s punch of the average inflation target (AIT).
Lagarde said the ECB has extensively discussed the recent appreciation of the EUR but the central bank does not target the exchange rate (like any other global central bank publicly). The ECB policymakers agreed to look through EUR strength at the meeting, but judged EUR broadly in line with economic fundamentals.
Regarding the pandemic QE program, policymakers consider it has been efficient and effective but did not announce any changes. But Lagarde also said the ECB is ready to do whatever it may require (including more cut in DRF to deep negative) to boost inflation. Lagarde also pointed out, like Fed, the ECB will also evaluate its strategy (policy framework) and thus it’s open for any AIT mechanism. So, the overall impact on the EUR was almost neutral as Lagarde is basically owlish, neither hawkish nor dovish.
On Thursday (10th Sep), as unanimously expected, the ECB kept its all key rates unchanged; i.e. main refinancing/interest (repo) rate at 0.00%; marginal lending facility (MLF) at +0.25%; deposit facility rate (reverse repo) at -0.50%. The ECB also kept its overall QE/APP including pandemic bond-buying unchanged vis-à-vis last modification in June, pledging pledged to buy up to €1.35T under its APP (Asset Purchase Program/APP).
The ECB macro-economic projection at a glance:
Overall, as per the above projections (average), the ECB will be far away from its inflation target of just below 2% even at 2022 and thus will be at ZIRP/NIRP till at least 2022 or forever (perpetual). As the unemployment rate may be still elevated around 9%, much above 2019 levels of 7.6%, the ECB may also continue its normal QE but may taper the pandemic QE after COVID-19 vaccinations by 2021. There may not be too much policy divergence between ECB and QE till at least 2022 and thus the ECB may resort to bolder forward guidance (jawboning) to ensure that EURUSD does not stay above 1.20-1.25 red line levels. The ECB may also incorporate Fed’s dual mandate; i.e. AIT strategy (as a price stability mandate) coupled with maximum employment under its new strategy to change the goal post to be at ZIRP/NIRP forever!!
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