The president of the ECB (European Central Bank), Mario Draghi convened a meeting in Frankfurt, Germany recently. He announced that the European Central Bank would maintain interest rates at their current level of 0%, thereby assuaging doves by not raising rates. However, the mixed message rattled currency traders as Draghi discussed a possible reversal in monetary accommodation, with talk of rising inflation. Then, the ECB president left open the possibility of additional monetary stimulus if the economy of the Eurozone reverses, but for now he is sticking to his guns.
Speculators’ Crosshairs on the Pound
After the announcement by the president of the European Central Bank, the EUR/USD pair plunged to 1.1489. Any moves that are perceived as dovish for the EUR will invariably weaken the currency against major competitors. But that negative sentiment was instantly reversed by his assertions that asset purchases could slow down towards the end of the year. As such, the EUR was boosted against its peers, notably the GBP. Draghi stressed that inflation is nowhere near where the ECB wants it to be, or where it should be. For this reason, the ECB is pushing for accelerated velocity flow of money through the economy to raise the inflation rate.
As such, the high level of monetary accommodation promulgated by the ECB will continue, and this acts as a suppressor of the EUR’s exchange-rate value. These developments will continue through the medium term. Draghi was quick to point out that the European economy is undergoing a robust recovery. The only two variables that need to rise are prices and wages. When that happens, the central bank will pull the trigger on interest rates. If the ECB decides to adopt monetary tightening, the nascent recovery in the European economy will slow down, or reverse. The back end of Draghi’s speech was particularly important: he stressed that the size, scope and duration of monetary accommodation could be increased if need be.
How is ECB policy affecting the GBP?
After his speech, speculators wasted no time shorting the EUR/GBP currency pair en masse. It plunged to an 8-month low against its European counterpart. Further, the EUR/USD pair reached a 2-year high. If the European Central Bank decides to reduce its asset purchases program in September, the EUR will be strengthened further against its trading partners. However, by the close of trade on Thursday, 20 July, the GBP pulled back against the USD, as it fell beneath the critical 1.300 level. Fortunately for UK traders and investors, the FTSE 100 index curled higher as the GBP declined.
As for the direction of ECB policy – it remains unclear. The president of the ECB struck a decidedly dovish tone, but left all options on the table. If real wages and inflation start to reverse, monetary tightening could kick in. This will cause the EUR/GBP pair to rally and add further pressure to the beleaguered sterling. At the end of the speech, Draghi drove the EUR/GBP pair to 1.1157. The EUR/USD pair was trading at 1.165 – a 2-year high. As it stands, economic stimulus in the Eurozone can be boosted by monetary accommodation.
The takeaway from the announcement is as follows: No change to the status quo as the Eurozone still needs monetary accommodation, but watch out for September tapering.
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