Euro firmer as ECB holds fire

Posted on September 8, 2016

Mario Draghi, President of the European Central Bank (ECB) attends the 49th annual meeting of the Asian Development Bank (ADB) in Frankfurt, Germany May 2, 2016. REUTERS/Ralph Orlowski©Reuters

Mario Draghi: low central bank interest rates are not the enemy

European Central Bank president Mario Draghi drew accusations of complacency after keeping a tight rein on monetary stimulus that helped extend a summer bounce for the euro.

The single currency strengthened against the dollar and the yen after the ECB left all its key interest rates on hold, repeating its statement from July that rates would remain at present or lower levels for an extended period of time.

    Analysts are sceptical the ECB will be able to resist further monetary easing for very long, because of the shortage of debt that meets the central bank’s criteria for the bond-buying programme it began last year.

    Patrick O’Donnell, fixed income investment manager at Aberdeen Asset Management, said there was “a whiff of complacency”, about the ECB, arguing that given the outlook for inflation and known political risks the central bank should have been more proactive at the meeting.

    “The lack of urgency will probably mean that financial assets will stay under pressure and the currency will continue to be squeezed. That will make the ECB’s job even more difficult,” Mr O’Donnell said.

    In fresh forecasts released on Thursday, the ECB predicted inflation of 0.2 per cent this year and 1.2 per cent next year.

    Foreign exchange traders were already buying the euro ahead of the ECB’s statement in expectation that policy would remain unchanged, and they pushed it higher still when Mr Draghi told journalists that the idea of extending the quantitative easing programme had not even been discussed by officials.

    At one point, the euro rose 0.8 per cent against the dollar to $1.1325, and against the pound, being worth £0.8490, before paring some of the advance.

    The weakness of the dollar has kept the euro on the front foot in recent weeks as poor US economic data damp expectations of the Federal Reserve raising rates. The euro has risen 1.9 per cent in the past two months.

    Lena Komileva of G+ Economics said investors were confused about the prospect of further ECB action over the next six months to sustain monetary easing. The lack of a clear signal that QE would be extended also hit eurozone government bonds. Yields on government bonds, which move inversely to prices, edged slightly higher on Thursday. The German 10-year yield rose 3 basis points to -0.089 per cent.

    Cosimo Marasciulo, head of European government bonds at Pioneer Investments, said that “we are close to a transition point where central banks generally and the ECB are really reassessing how much interest rates can fall.”

    “There was a strong emphasis on the role fiscal policy should have . . . almost like saying monetary policy is reaching a point where there is limited scope for further easing.”

    The ECB’s introduction of negative interest rates has drawn heavy criticism from the banking industry whose profitability has been eroded.

    Marc Ostwald, a strategist at Admisi, said the ECB showed a “clear desire to put some indirect pressure on governments to act on fiscal measures and structural reforms, by not signalling further easing, and indeed by acknowledging that there will be ‘consequences’ as a result of this unprecedented period of negative rates and unconventional policy measures”.

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