Monetary Policy Draghi disappoints markets by singing the same song

The ECB chief stayed the course this week, but traders are testing his resolve by pushing the euro higher.
Paper tiger?

Mario Draghi faced a topsy-turvy world at his press conference Thursday as his determinedly firm stance to maintain a lax monetary policy for the euro could not hinder the joint currency’s rise against the dollar despite tighter money in the US. In a normal world, currency flows gravitate toward higher interest rates, but that’s not happening.

Remarks from US Treasury Secretary Steve Mnuchin in Davos this week to the effect that a weaker dollar is beneficial for US trade certainly contributed to flows out of the US currency into the euro. Mr. Mnuchin subsequently clarified that he was not trying to talk the dollar down and the United States still believes in currencies floating freely in markets.

In any case, the effort of the European Central Bank president to dampen the euro’s rise backfired as market participants disappointed with his failure to change his tune retaliated by putting more funds into the euro. The euro rose to a three-year high of $1.2537 in the wake of the ECB meeting.

Draghi isn’t talking up the euro, he isn’t talking it down enough. Ulrich Leuchtmann, foreign exchange analyst, Commerzbank

“It looks as if the market wants to test at what euro rate the ECB’s pain threshold is reached,” commented Thomas Altmann at QC Partners. For this analyst and others, the ECB president, while criticizing volatility in the currency markets, failed to criticize the actual exchange rates of the euro.

“Draghi isn’t talking up the euro, he isn’t talking it down enough,” commented Ulrich Leuchtmann, foreign exchange analyst at Commerzbank. “The market interpreted that as if there’s still room to go up. The ECB sees no need to intervene.”

The dilemma for the ECB is that it doesn’t want to remove monetary accommodation until there are clear signs that inflation is picking up. But the very strength of the euro in currency markets curbs any inflationary pressure.

On this prickly point, Mr. Draghi said it was too early to tell the impact of exchange rates on inflation, but the ECB will be watching closely. “The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability,” Mr. Draghi said.

The ECB president didn’t hesitate to blame this volatility at least in part on “communication” as an “exogenous” influence on rates. “But not by the ECB, but by someone else,” Mr. Draghi said, clearly referring to Mr. Mnuchin’s comments in Davos.

He went further in his criticism. “This someone else’s communication doesn’t comply with the agreed terms of references,” Mr. Draghi said, referring to an accord reiterated most recently at the International Monetary Fund in October for authorities not to target exchange rates for competitive purposes.

Beyond exchange rates, the “overall status of international relations,” such as rising pressures for protectionism might prompt a change in course, Mr. Draghi hinted. “If all this were to lead to an unwanted tightening of our monetary policy,” he said, “then we will have to just think about our monetary policy strategy.”

At the same time, he was quick to reiterate that he saw “very few chances” of an ECB rate hike this year. The bank left its benchmark rate unchanged at 0 percent and its deposit facility rate also unchanged at -0.40 percent.

Mr. Draghi was equally noncommittal – that is, dovish – with regard to the bank’s asset purchase program, currently running at €30 billion a month at least through September. He suggested the bank is ready to extend it or even expand it if necessary and would not say what will happen when the current program runs out. This unconventional tool pioneered by the US Federal Reserve and known as quantitative easing creates more central bank money and provides further accommodation when interest rates are at or near zero.

Ironically, in a press conference devoted largely to a discussion of central bank communication, Mr. Draghi did not communicate any clear message. The confusion reigning after his remarks was evident in the lessons various analysts drew from them.

The chief strategist at Nordea Bank in Scandinavia, Jan von Gerich, continues to expect that the ECB will extend its asset purchase program another six months in September, reducing it to €15 billion a month, and won’t raise rates until December 2019. Though he conditions his forecast on inflation developments, he comments that this “clearly more dovish than what is priced in the markets.”

Nomura’s global market analysts, on the other hand, think that asset purchases will end in September and the deposit rate, at least, will be raised 10 basis points this December. They, too, believe the ECB will wait for indications that core inflation is on the rise but consider that the current “stance of policy is out of kilter with the underlying fundamentals” as economic growth in Europe picks up pace.

Handelsblatt reporters Jürgen Röder, Frank Wiebe and Jan Mallien contributed to this report. Darrell Delamaide is a writer and editor for Handelsblatt Global in Washington, DC. To contact the author: [email protected].