The ECB, the Pope and the EUR

It’s not often that the Pope gets mentioned in an ECB press conference, but that is what happened today. At his press conference Draghi was asked to comment on a tweet from Pope Francis about the tragedy of rising unemployment in the Eurozone. After a brief pause, Draghi said that the situation is frustrating for the ECB as well as the Vatican as its efforts fail to generate enough growth to get businesses hiring once again.

The trouble is that today’s ECB rate cuts (25 basis point cut to the base rate and 50 basis points to the marginal rate charged to banks who borrow overnight funds at the ECB) are unlikely to help get people back into work in Spain, Portugal, Italy or Greece. Firstly, real interest rates (when adjusted for inflation) are negative even with the steep fall in inflation we have seen recently, thus, the impact of a rate cut on the normal person is fairly minimal. Secondly, access to credit for banks is not the problem. Draghi was right today when he said that the ECB can’t be accused of not providing the financial system with enough liquidity to boost the financial sector. Since a strong financial sector is usually a key driver of growth, why is there still a problem? It’s a chicken and egg situation. The banks don’t want to lend, not even cheap money, if persistently high unemployment increases their prospect of default and bad loan rates. No one seems to have the answer to this point, not even the Pope, which is why today’s ECB policy changes are unlikely to have any impact on the long-term outlook for the Eurozone.

The reaction in the markets had something for everyone. The rate cut was expected by the market, so we saw a jump higher on the back of less “aggressive” action from The ECB. However, it was the Q&A that provided more insight into the ECB’s thinking. Not only did we find out that the ECB would consider a negative deposit rate (the rate it pays banks to keep funds at the ECB, which is already 0%), but Draghi said the Bank stands ready to act again if necessary, suggesting that base rates could be cut further. Draghi also said that there was strong support for today’s rate cuts, suggesting that the powerful Bundesbank is on board with looser monetary policy and could even be persuaded to cut rates further.

The prospect of future rate cuts was not expected by the market, hence the drift lower in EURUSD, so far today 1.3040 has been the low, above key 1.3010 50-day sma support. Likewise, EURJPY has also been a major mover today, rising to 129.90 at one stage, before collapsing back to 127.60, just above key support at 127.50. So where do we go from here? Rate cuts and liquidity are good for stock markets and European markets mostly closed higher, although Spain and Italy closed down. These economies could do with more than just rate cuts and stock investors’ know it…

In terms of the EUR, 1.3220-40 is a massive resistance level, and right now the market has no appetite for holding EUR above here. However, we tend to think that the extent of the downside will be dependent on tomorrow’s NFP. If it was based on growth prospects alone surely EURUSD would be back at 1.20 and EURJPY would be closer to 110.00, however it’s not. Yield is a key driver in FX, and right now the ECB isn’t embarking on QE but the Fed and BOJ are. Thus, a miss for NFP’s tomorrow could see a reversal in the EUR back to the 1.3230 highs that have thwarted positive momentum this week, as QE4, 5, and 6 come back into view and weigh on the greenback. However, a stronger payrolls (the current Bloomberg estimate is for 140k), could see the dollar rebound sharply, sending USDJPY above 100.00 and EURUSD flying headfirst down the southern highway. A payrolls number close to the magic 200k could see EURUSD fall below the 1.2970 level – the 200-days sma – which would be a very bearish development for this cross, opening the way for a move back to the 1.2745 lows form early April.