By Anthony Harrington
There is a grim inevitability about the way in which analysts pour over every utterance from senior figures at the European Central Bank, weighing every phrase for its dovish or its hawkish qualities. At the time of writing, more than a week has passed since the ECB decided to try to stimulate the flagging EU economy by cutting its main refinancing rate to a record low of 0.5%. Banks and analysts had been on tender hooks wondering which way the ECB will go. Even had the ECB done nothing and left rates unchanged the story would not have ended there. Analysts and the media scrutinize ECB decisions intensively, looking for clues as to whether the ECB is leaning more towards a dovish than a hawkish posture, and vice versa. Following the rate cut, and partially due to better-than-expected US non-farm payroll figures, the dollar has surged against the euro and this, allied to the base rate cut, which had been widely expected, caused the euro to drop from a high of 1.37210 against the dollar back on February 1, to as low as the 1.297s by Friday, May 10.. From the moment ECB president Mario Draghi announced the rate cut the euro began to slide and may well still be deteriorating. Some pundits are talking about 1.24 as the real "fair value" balance point between the euro and the U.S. dollar, which would give the euro plenty of scope for further falls. Clearly the ECB's actions and words have a huge influence.
Why does all this matter? The euro is suspended at present between two polar opposite targets with respect to the U.S. dollar. There are scenarios that could see it shift up towards $1.4 or even $1.5 dollars to the euro, but if the ECB cuts rates a tiny bit more, and extends its accommodative monetary policy in an attempt to stimulate the EU's near moribund economy, then, with the U.S. showing signs of recovery, the euro could crash back to £1.10. Some readers may still be tempted to ask: does this matter? The euro is traded on the global FX markets at five decimal places after the dot. The euro/dollar pair see trillions of dollars traded daily. A 10,000 point move is huge in FX terms so nobody wants to be "long" if the euro is going to crash, and they certainly don't want to be short if it is going to surge. Hence all the analyst noise.
Externally driven inflation through food and fuel price increases is not looking like the threat it was, which creates still more room for the ECB to be accommodative. With the U.S. producing increasing amounts of its own oil through fracking techniques there is a growing feeling that the demand side of the oil equation is looking weaker than it has for years. The U.S. certainly, will not be importing anything like the quantities it was, and both China and India have seen slowdowns in their economies, which, again, hits demand for oil. So once again, fuel price driven inflation is easing back, if it hasn't quite vanished as yet. The point here is that with less inflation to worry about, the ECB can stimulate the eurozone economy rather more than it could if inflation was a worry. So that too, is likely to impact the euro negatively since money printing in its various guises is generally held by the markets to have a depressing effect on a currency.
Yet peripheral debt in the eurozone has suddenly become a lot cheaper. The Italians, for example, managed to get a debt auction away recently that was within sight of German debt prices, which would have been unthinkable a month or two back. Nevertheless, the eurozone could scarcely be said to be out the woods. Something of this has been reflected in the euro's slide against the dollar since the rate cut on May 2. On May 1, the euro dollar pair were trading in the region of 1.32 something dollars to the euro. By May 13, the euro had slipped to 1.295 something. Given that there is considerable consensus that the U.S. is returning to growth while the eurozone is still embattled, it looks as if the long-term trend for the euro has to be down (long here meaning over the next six months or so). That will be good news for Europe’s manufacturers, who wouldn't have relished seeing the euro creeping upwards against the dollar. However, both businesses and FX traders will have to keep a wary eye on Draghi and the ECB, since it is now abundantly clear that the ECB can tilt the market up or down whenever it so chooses.
Draghi's comment, made during his rate cut speech, about the ECB being willing to think about going to negative interest rates if the situation called for it, sent the euro into a downward spiral that reversed briefly when ECB spokespeople started "revising" Draghi's words, claiming that the comment had little short-term relevance. However, the thought is now firmly planted in the "hive mind" of the FX community, giving the ECB the perfect lever to talk down the euro any time it pleases. The next month or two looks likely to write another lively chapter in the history of the euro.