Jane Foley, Research Analyst at Rabobank, suggests that several inferences can be drawn from the comments from ECB President Draghi yesterday that he does not anticipate it will be necessary to cut rates further. Key Quotes “In the context of the range of policy announcement made yesterday, this remark may have meant that Draghi was very mindful of the potential side-effects of negative interest rates, not least on bank balance sheets. The composition of the ECB’s latest package of easing measures appears to be aimed squarely at the real economy and this is most evidence in the new TLTRO programme. Specifically, the introduction of a bonus clause, instead of a penalty, makes this a far more attractive finding instruments for banks suggesting that banks should be better equipped to stimulate lending into the real economy. That said, we are still sceptical as to the pass through since many investment grade corporates are not short of funding. Even so, by placing emphasis on this measure rather than on the likelihood of increasingly negative rates, the ECB may finally be turning its nose up at currency wars. Measured from the middle of 2014, the ECB has been a successful player in the currency war on the back of the sharp drop in the value of the Eurozone’s effective exchange rate between July 2014 and March 2015. Even though EUR/USD has been trading in a broad range since then, those losses in the EUR have meant that on most measures of fair value the EUR is still undervalued meaning that exporters in the region should still be feeling a benefit of a soft exchange rate. Currency wars, however, are clearly a zero sum game. The ECB’s decision to push its discount rate into negative territory in June 2014 sparked a wave of retaliatory measures by the smaller European central banks. The impact, however, did not stop there. Fed Chair Yellen recently admitted that the FOMC did not anticipate the degree of USD strength in the second half of 2014. In a speech late last year Fed Vice-Chair Fischer outlined how the gains in the US effective exchange rate had impacted US exports and inflation. Since the strength of the USD had done a lot of the heavy lifting already, it can be inferred that this is a prime reason why the Fed has not has to hike rates by as much as many commentators were anticipating a year or so ago. The ripple effects of currency wars went further than this. We would argue that the strength of the USD was a primary reason why the PBoC were forced to de-value the CNY last summer. The value of China’s effective exchange rate was been dragged higher by the de factor CNY-USD peg or to put it another way China, like the US, was paying the price for the fact that both the ECB and the BoJ had managed in recent years to push down the values of their effective exchange rates. While China was blamed for created waves of volatility in global markets last summer, we would argue the responsibility for currency wars does not lie with the PBoC. If the ECB has decided to change tack and move away from ever lower rates and currency wars, this will be relief to many other central banks. There may, however, be no honour in the decision. It is possible that the ECB has been forced to consider different mechanisms for stimulus because against a backdrop of limited risk appetite, investors have limited desire to short the EUR. Market Focus will now switch to the Fed meeting next week. Assuming the Fed can still hike rates later in the year we still see scope for some limited downside for EUR/USD but we have modest increased our 12 mth forecast for EUR/USD from 1.05 to 1.07.” For more information, read our latest forex news.