EUR/USD: ECB Delivered Bold Stimulus Package, But May Be Out Of Ammo Now

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EUR/USD: ECB Delivered Bold Stimulus Package, But May Be Out Of Ammo Now

• Yesterday the ECB delivered a bold package of easing measures. The refi rate and the marginal lending rates were lowered by 5bp, to 0.0% and 0.25% respectively. The deposit rate was cut by 10bp to -0.40%, in line with our and the consensus forecasts. The forward guidance on rates is still there, but looks somewhat weakened by a more cautious tone about the impact of negative rates on banks’ profitability, which casts some doubts about the downside rate potential from here (the FX market took notice). Liquidity measures were rather aggressive, with a new set of four TLTRO with maturity of four years and the interest rates that can range from the refi rate (currently at 0.0%) to the depo rate (currently at -0.4%), depending on lending volumes. There is plenty of liquidity insurance for banks at times of rising market uncertainty and large upcoming bond redemptions. The monthly pace of asset purchases was raised to EUR 80bn from EUR 60bn, more than generally expected. Although the lack of program extension beyond March 2017 leaves the additional balance sheet expansion via QE at an unimpressive EUR 240bn, this is more than offset by the more front-loaded pace of purchases and the inclusion of non-bank corporate bonds in the list of eligible securities.

• Mario Draghi said that the idea to adopt a tiered framework for the deposit facility was eventually dropped mainly to avoid signaling that there is no lower limit on rates. Obviously, the ECB is facing a tricky balancing act: on the one hand, the central bank wants to leave the door open to cut rates further if needed, while on the other hand they want to signal to the market that they do care about side effects of easing measures on banks’ profitability. Overall, the bar for cutting deeper into negative territory now appears somewhat higher.

• The ECB’s new set of macroeconomic projections was very much as we had anticipated, envisaging lower inflation and a more cautious growth outlook. The inflation forecasts were lowered in a front-loaded fashion, mainly reflecting lower oil prices at the cut-off date of mid-February (but consider that oil prices are already up 20-25% from that level). The CPI projection for 2016 came down to 0.1% from 1.0% in December, with 2017 now seen at 1.3% from 1.6%. In 2018, inflation is expected to average 1.6%, implying a move towards price stability sometime in the second half of 2018. The GDP number for this year was lowered by 0.3 percentage points to 1.4%, with growth in 2017 seen 0.2 percentage points weaker at 1.7%, and 2018 at 1.8%. The deterioration from December is mainly driven by weaker global growth and risks remain tilted to the downside.

• The EUR/USD dropped initially after the decision, and our long position was closed at 1.0920 – we took only a small profit on our long position. The reaction was short-lived and the EUR/USD surged to more than 1.1200 soon as the ECB is running out of ammunition with which to weaken their currencies and raise inflation. The 4-cent spread between the euro's highs and lows on Thursday equalled any of the euro's most volatile days over the past five years and were similar to moves after two of the past year's key ECB meetings - in December and last March.

• In our opinion there will be no more easing steps from the ECB. Investors focus is turning now to next-week Fed meeting. We think the Fed is likely to keep its hawkish rhetoric, but there may be less than four hikes this year assumed in policymakers’ forecast.

GOLD Rises On Weaker Dollar, But India Strikes Hit Demand

• Gold climbed to a 13-month high on Friday before pulling back slightly, as the euro hovered near a three-week peak against the dollar after the European Central Bank signalled it was done reducing interest rates for now.

• Spot gold rose as far as 1,282.51 an ounce, its strongest since February 3, 2015. Bullion climbed 1.5% on Thursday, its biggest single-day gain in a week, and was on course for a second weekly rise. The next major resistance level for gold would be around 1,306, reached in January last year.

• Holdings of SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, rose to 25.68 million ounces on Thursday, the highest since August 2014.

• With the metal clinging to this year's gains, physical gold demand slowed in top consumer China this week. Gold demand in India was sluggish as jewellers were on strike to protest against a government decision to impose an excise duty of 1% on jewellery sales. The government was forced to roll back an excise duty it imposed in 2012 after a strike by jewellers that lasted 21 days.

• Gold outlook is bullish and our long-term target is 1,400 despite expectations that the US Federal Reserve could raise interest rates this year.