FXStreet (Guatemala) – Analysts at Bank of Tokyo Mitsubishi explained that you’d be forgiven for asking this question given the financial market reaction to the 10bp cut in the deposit rate to -0.30% and the extension of the ECB QE program of six months, taking the total purchase amount from EUR 1.14trn to EUR 1.5trn.
Key Quotes:
The German 2-year yield jumped 13bps, the 10-year yield increased 20bps and the Euro Stoxx index plunged 3.6%. And on an intra-day high-low basis, the EUR/USD rate surged 4.3%. In percentage terms that’s the largest one day gain this side of the Great Financial Crisis – so surpassing all market reactions to bailout deals and other policy responses during the debt crisis in the euro-zone.
We obviously acknowledge that the euro short position was larger than we anticipated but even taking that into account, the euro gain looks over done. EUR/USD was trading around 1.1300 when Draghi first hinted at a deposit rate cut at the October meeting, but the drop in EUR/USD since then to close to 1.0500 was not only about the ECB. The Fed also moved closer to a rate hike over this period – since the ECB meeting in October, the US 2-year yield is up about 35bps. The 2-yr swap spread since the October ECB meeting has seen the US premium over the euro-zone rise from 74bps to 114bps ahead of the announcement – that spread is now at 105bps. So it is worth reminding ourselves again that the ECB did cut – the EONIA curve implied 14/15bps was priced, so it was less than expected. But a cut it was along with extra QE. As market participants see that this was more about positioning and illiquidity appetite for further euro buying should quickly recede from here.
Our sense of what happened yesterday is that ECB Draghi and possibly Chief Economist Praet underestimated the degree of opposition to a more aggressive policy response. The demeanour of President Draghi yesterday was different to before and we sensed certainly a despondency that may have reflected a defeat at the meeting for those arguing for more. We are guessing of course but we see that as a logical explanation for what has to be a major communication gaff. The ECB knew what was expected and from a credibility perspective to cut the deposit rate and increase QE, which then result in a notable tightening of financial market conditions is not what the Governing Council would have wanted. It is worth noting that President Draghi speaks this afternoon at 1645 in New York.
It was also notable that there was next to no powerful forward guidance in the press conference. President Draghi’s first question was whether the deposit rate was now at the lower bound – he dodged the question. There was the standard forward guidance piece in the statement but in the Q&A Draghi was certainly more reserved than we expected. The euro will in all likelihood now begin 2016 at a level that is higher than we anticipated (1.0400). But we still envisage downward pressure on EUR/USD re-emerging. The reaction to the more cautious ECB will fade and what is clear is that the ECB and the Fed are going in different directions, only perhaps a little bit more cautiously than had been expected before yesterday.”
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