ECB’s ability to weaken the euro continues to diminish - MUFG

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 11, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Lee Hardman, Currency Analyst at MUFG, notes that the euro has remained stronger in the Asian trading session after strengthening sharply following the ECB’s announcement of a comprehensive package of easing measures.

    Key Quotes

    “It was the second consecutive time that the euro has strengthened following the announcement of further ECB easing following on from the sharp rally back in December. What is more surprising on this occasion is that it is harder to describe the comprehensive package of easing measures as disappointing which has provided a bullish signal for the euro by highlighting that is becoming increasingly difficult to weaken it further. The euro is already significantly undervalued and has been consolidating at lower levels for just over a year now.

    The main trigger yesterday for the sharp strengthening of the euro was the statement from President Draghi that he doesn’t anticipate it will be necessary to cut rates further from today’s perspective which prompted the market to scale back expectations that rates are likely to be lowered deeper into negative territory. Expectations for even lower rates were dampened further by comments from President Draghi that the Governing Council discussed the option of introducing a tiered deposit system but decided against it as it was viewed as too complex and they didn’t want to signal that there was no lower limit for rates.

    A further rate cut has not entirely been ruled out as the President Draghi stated as well that new facts could change the stance on rates although the hurdle for lower rates has clearly increased.

    The ECB is clearly more worried as well that continuing to lower rates further into negative territory could damage the transmission mechanism of monetary policy through damaging bank profitability and their willingness to lend. As a result the ECB announced steps to provide support to banks and encourage lending.

    The ECB increased the size of its QE programme by announcing it will purchase a further EUR20 billion of assets per month. However, the duration of the programme was not expanded beyond March of next year although President Draghi signalled it could yet extend beyond. As a result, the overall size of the QE expansion fell short of our expectations increasing by a further EUR240 billion which was one of the more disappointing aspects of the package.

    The initial strengthening of the euro after further ECB monetary easing has increased upside risks to our outlook for modest euro weakness during the rest of the year. The ECB’s inability to weaken the euro further strengthens the case that the euro may have already bottomed.

    As a result, we will continue to monitor closely how the euro trades in the near-term. Still, the initial strengthening of the euro could yet prove to be an overreaction and temporary given that it does not appear fully consistent with the comprehensive package of easing measures announced by the ECB.

    Our forecasts for EUR/USD to grind lower during the rest of the year are more importantly driven by our view that the Fed will continue to gradually tighten policy. The recent weakening of the US dollar has eased monetary conditions in the US, and increases the likelihood that the Fed will resume rate hikes in Q2. The euro is likely to be undermined as well in Q2 by the heightened risk of negative Brexit spill-overs.”
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