• The ECB struck a dovish tone in its statement and press conference today. It is becoming a master of verbal intervention as it managed to dampen recent de facto tightening without taking any action – much as was the case with the OMT programme, which has so far managed to lower Spanish and Italian bond yields without buying a single bond. 
  • The ECB views the rise in short rates as a sign of confidence but is ready to provide liquidity as needed. It will closely monitor conditions in the money markets. 
  • On the euro exchange rate, the ECB now specifically mentioned it as a downside risk to inflation but otherwise the tone was balanced. The ECB will evaluate the effect on inflation in the new economic projections next month. 
  •  ECB president, Mario Draghi, does not regard the recent currency moves as the effect of deliberate action but as a reflection of policies to revamp economies. Hence, he doesn’t seem to buy into the currency war concept. 
  • Rates and EUR/USD declined on the back of the soft tone. We expect this to continue in the short term. However, EUR/USD is expected to resume the uptrend in coming months and we look for a steeper EUR swap curve. 

A slightly more dovish tone

The ECB struck a slightly dovish tone today as there were explicit changes to the statement on the back of the recent rise in short rates and appreciation of the euro. 

On the repayments of LTRO money and the rise in short rate: the ECB noted it reflected a rise in confidence and was at the discretion of the counterparties. The ECB will “closely monitor conditions in the money market and their potential impact on the stance of monetary policy, which will remain accommodative with the full allotment mode of liquidity provisions.” This is another example of verbal intervention from the ECB indicating that if short rates go up too much the ECB will likely respond. Draghi added at the press conference that he wouldn’t make too much of the EONIA increase but that the ECB was accommodative and would provide liquidity as needed. 

Note that the message was essentially unchanged compared to the recent comments from ECB Executive Board member, Peter Praet, who on 29 January said, “We will exert vigilance to ensure that ... the overall liquidity conditions prevailing in the money market will remain consistent with the degree of accommodation that the current outlook for prices and real activity warrant”. 

On the strengthening of the euro, the tone also signalled “monitoring” but without saying it explicitly. Firstly, the ECB now added the euro as a downside risk to inflation. Secondly, it actually also indirectly hinted at the euro when speaking of downside risks to growth as it now also sees these as stemming from the possibility of weaker-thanexpected exports. 

Since global growth data has generally been strengthening it is hard to see this otherwise than a risk from a stronger euro. 

At the Q&A session, Draghi reiterated the message from earlier that it isn’t targeting the currency but that it does affect growth and price stability. The ECB sees it as a sign of confidence but will evaluate whether or not it alters the risks to price stability and Draghi referred to next month’s new staff projections for inflation. Hence, the ECB seems sidelined for now but analysing the impact on the outlook for inflation. In contrast to some other central banks which are complaining about the currency war, Mario Draghi dismissed this by saying that the currency moves were not based on a deliberate action to weaken the currencies but an effect of efforts to revamp the economies. 

Assessment and outlook 

So far, the ECB has had great success with intervening verbally. It is watching developments and signalling a willingness to act if necessary to keep the accommodation it wants to achieve. Today, this was enough to cool the market down and send yields at the short end lower and weaken the euro. 

We continue to believe that it will not be necessary to actually act and cut rates or make new long-term liquidity provisions. As economic indicators continue to improve, the bar for the ECB actually acting diminishes. 

However, if the euro climbs above 1.40 and we get signals that the recovery is losing steam, this could trigger an ECB rate cut. 

Market comment 

Short-end rates had moved higher ahead of the press conference, so the bar for further steepening of the EUR money market curve was pretty high. Since Draghi struck a fairly dovish tone, the price dynamics reversed over the press conference. For those worried about a rapid rise in EONIA rates, Draghi calmed fears by saying that he sees excess liquidity remaining well over EUR200bn after the second LTRO repayment. The consensus among watchers is that the EONIA fixing will be little affected when excess liquidity is in this territory. Furthermore, he said that the ECB is ready to provide liquidity as needed. Overall, the pressure on the short end of the curve should recede. The overall line in today’s communication supports a steepening of the EUR swap curve (2/5 and 2/10 etc). 

On the currency in the near term, the risk is on the downside for EUR/USD as EUR rates come somewhat lower. In the medium term, however, we believe that euro setbacks will prove temporary and we expect EUR/USD to gradually trend higher towards 1.40 in coming months.