Draghi takeouts – EUR weaker despite the removal of easing bias
The ECB removed a key element of its easing bias. That was a statement that they were prepared to expand its asset purchase plan if the outlook deteriorated.
Specifically, the removed sentence was: “If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase the asset purchase programme (APP) in terms of size and/or duration.”
Some, not all, analysts thought that this would go, but most would agree that it was past its used by date. The ECB had probably kept it in this long because it did not want to spook a market that was highly reactive to any suggestion of approaching QE policy tapering or exit.
The EUR spiked briefly when it learned that this sentence had been removed from the press conference introductory statement. However it then quickly retraced, and has subsequently fallen significantly on the day.
I don’t want to read too much into price action, as there has been a lot of noise lately that is hard to square with developments. But it does suggest that the market has largely come to terms with the gradual wind-back in ECB policy easing, and the EUR may have largely built-in an end to QE asset purchases in September.
The EUR may now have less upward momentum, or that upward momentum may require clear evidence that the ECB is achieving its mandated inflation goals and will consider a faster pace of policy exit.
The EUR may have also fallen today as the market absorbed comments from Trump suggesting that he may soften his rollout of tariffs, to limit implementation with some allies. However, it was far from clear that this should include the Eurozone. Trump also talked about NATO funding and how it was still unfair to the USA, making a connection between military alliances and tariff implementation.
It does appear that a softer tariff tone today more broadly strengthened the USD (even as US bond yields eased somewhat). However, it is hard to understand how the tariff news has and will in future impact on FX.
You might say that the tone of the ECB press conference de-emphasised the removal of the asset purchase plan easing bias, and place more focus of the other parts of the statement that guide the path for rates and its asset reinvestment policy. In other words, Draghi was trying to ensure the EUR did not rise too much.
The fact that the EUR has fallen during the press conference and remains lower may be seen as a win for Draghi and the ECB that has expressed concern over the strength of the exchange rate since last year.
You might say there was a dovish tone in the press conference, but the reality is that Draghi’s tone has been pretty even for much of the last year. It would be more accurate to say the market was more amenable to absorbing the dovish parts of the presser.
Comments on the policy outlook
“If you look at the past structural reforms, the increase in labour supply, the increase in participation rate, the increases in productivity, all this increases the uncertainty about the potential output growth path, and therefore the size of the slack in the economy. So the policy will continue to be reactive.”
This is dovish, suggesting that the ECB can see the possibility that potential output is picking up, and this might allow the economy to grow faster without triggering inflation.
Draghi used the word “reactive” several times, signalling that the ECB is not on a pre-determined path for exit and will respond to evidence that inflation is moving up or otherwise.
“Even though we have strong growth, we still have subdued inflation, and our mandate is in terms of price stability, so victory cannot be declared yet.”
This appears meant to convey that strong growth indicators alone may not be sufficient to argue for a faster pace of policy exit.
Draghi said that the ECB Governing Council had removed the bias to expand QE, but there remains a commitment to reinvest maturing assets and keep rates low for an extended period beyond the end of the QE asset purchases. Draghi spent time emphasizing these “other pillars” of their easing program.
When asked why the Governing Council dropped the QE easing bias this time around, Draghi said it was more about some improvement in the confidence in the inflation forecast, while the outlook had not changed much.
“We look at underlying inflation to judge the robustness of the convergence. Some measures are have ticked up a little, but in general, they are still subdued. The picture is no much different from last time.”
“Incoming information since the last meeting has reduced the variance, but doesn’t send any new signal.”
“We have a narrowing of the variance around the convergence path, which confirmed our previous confidence.”
With respect to the QE easing bias removal, he said, “These are unlikely contingencies now that would activate the easing bias.”
In discussing recent equity market turmoil that followed higher US wage data last month. He said, “In Europe the situation is different, we don’t see wage growth or inflation of that amount.”
This is a subtle hint to the market that the Eurozone is still significantly behind the US is returning to its inflation target.
Forecasts
The growth forecast was revised up for this year, unchanged for 2019/2020. “Annual real GDP increasing by 2.4% in 2018, 1.9% in 2019 and 1.7% in 2020.”
The inflation forecast was “revised down slightly for 2019 and remains unchanged for 2018 and 2020”. “Annual HICP inflation at 1.4% in 2018, 1.4% in 2019 and 1.7% in 2020.”
The fact that there was a slight downward revision for inflation in 2019, and no change in the inflation outlook in 2020, still a bit too far below the “below, but close to, 2%” ECB inflation goal, may be contributing to the sense that ECB policy exit will be gradual.
Comments on tariffs:
On the steel and aluminum tariffs, Draghi said that the immediate impact of the trade measures is not big, but went on to highlight the significant risks that might arise from a trade war.
“Disputes should be discussed in a multilateral framework, that unilateral decisions are dangerous. Also there is a concern over the state of international relations, because if you put tariffs against your allies, one wonders who the enemies are.”
“On assessing the final impact of these measures, many factors come into play. First of all, is there going to be a retaliation or not?”
“Second, what is going to be the response of the exchange rate? So far we have seen that whenever there was a threat of putting tariffs towards another country, it was the dollar that would appreciate. But things can be different from time to time.”
“Third, and most important is the effect of trade wars, is the effect on confidence. A negative effect would be negative on both inflation and output.”
Interestingly, Draghi appeared to try and convince the market that the appropriate response to the tariff talk should be a stronger USD. This speaks to his underlying mindset of trying to prevent appreciation of the EUR.
A big dig at US financial deregulation trends
“There are two main risks that one can see today. One is trade. There is another risk that is less mentioned these days, and that’s the risk of financial deregulation in other major jurisdictions. We should not forget what the situation was before the crisis. Like today we had an expansionary monetary policy that was justified by the conditions of that time, as ours is justified by the conditions today. But in the 10 or 12 years before the crisis there has been a systematic disruption of financial regulation in the major jurisdiction.”
“And this combination… I would flag this as one major risk for the years ahead, that we repeat the same mistake.”
“I should say also that the ‘we’ is no right in this context because the Eurozone, both national legislators and European legislators, and the EC are certainly not on that path. But we are talking about a global market. And massive deregulation in one part of the market is going to affect the whole world.”
Draghi made a pretty pointed jab at the USA government both on its trade policy and a trend towards financial deregulation, suggesting both were reckless and bad policy.
INTRODUCTORY STATEMENT, Mario Draghi, President of the ECB, 8 March 2018 – ECB.Europa.eu
YouTube live streaming of the press conference, 8 March 2018 – ECB.Europa.eu