3 Reasons Behind EURO's V-Shaped ECB Reversal
|The European Central Bank went above and beyond today in rolling out a massive stimulus package. Their actions not only reflect their desperation but also their resolve to boost the Eurozone economy and mitigate the risk of recession. These were the five steps taken today and when they were first announced, the combination of efforts drove EUR/USD to a low of 1.0927. The ECB also lowered their inflation and GDP forecasts for 2019 and 2020. According to ECB President Draghi, their actions were prompted by 3 elements - a more marked slowdown in the Eurozone economy, the persistence of downside risks and their baseline scenarios that included downward revisions to all of their inflation projections. However instead of extending its losses below 1.09, EUR/USD reversed sharply after Draghi's press conference to trade well above 1.10.
5 Part ECB September Stimulus Package
- Interest rates cut by 10bp to -0.5%
- ECB dropped their calendar guidance
- Restarted bond purchases
- Changed their TLTRO rate to eliminate 10bp spread and provide more favorable bank lending conditions
- Introduced a 2 tier reserve system that would exempt part of bank holdings from negative rates
We can find at least 3 reasons for the turnaround in the euro. First and foremost, ECB President Draghi called on governments to go big with fiscal stimulus. He said "reform implementation must be stepped but substantially" to raise long term growth potential. The central bank has long felt that monetary stimulus alone won't be enough and by doubling down on a massive stimulus package, he's put the ball in their court. With his bold curtain call, Draghi is taking the problem of low growth seriously and saying now its time for the governments to act. Euro also u-turned on the hope that the stimulus will work as the promise of unending QE should go a long way in boosting the economy. The market also thinks that all of this guarantees a rate cut from the Federal Reserve next week and the prospect of Fed easing is bullish for EUR/USD.
3 Reasons for EURO Recovery
- ECB lays on fiscal stimulus pressure
- Unending QE will have positive impact on the economy
- ECB actions guarantee Fed cut next week
Looking ahead, we believe that today's actions could mark a bottom for EUR/USD. One of the biggest near term risks for the euro is behind us. Christine Lagarde takes over as head of the ECB in November and like Draghi, she's a big supporter of fiscal stimulus. The difference between Draghi and Lagarde is that she's more politically rooted and could have a greater influence on Germany. If the Eurozone existed in a silo, we would declare this a sustainable bottom for euro. However, US President Trump made it very clear that he's not happy the ECB is "weakening the euro," so we need to be mindful of the risks including retaliatory actions from the US (including tariffs) and Brexit.
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