Draghi Won’t Send a Rate Hike Gift to the Gold Bulls

The ECB eased its monetary stance. It launched another round of cheap loans to banks and promised to keep interest rates unchanged this year. It means that Draghi will not hike during his presidency. What does it all mean for the gold market?

ECB Unveils New Monetary Stimulus in Response to Slowdown

The ECB left its interest rates unchanged. But it pushed out the timing of its first post-crisis rate hike until 2020 at the earliest. As we can read in the monetary policy statement.

The Governing Council now expects the key ECB interest rates to remain at their present levels at leastthrough the end of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. 

It means that Mario Draghi will end his mandate as the ECB President without hiking the interest rates. Moreover, the ECB slashed its growth and inflation forecasts for 2019 and lowered those for 2020 and 2021. The bank now sees euro zone growth at barely 1.1 percent this year, compared to the 1.7 percent it projected in December. And it sees the CPI rate to rise only to 1.6 percent in 2021. Acknowledging that Europe’s slowdown could be longer and deeper – after all, Germany stagnated in the fourth quarter, while Italy was in outright recession – the ECB offered banks a new round of cheap loans, called TLTRO-III, to help revive the euro zone economy.

A new series of quarterly targeted longer-term refinancing operations (TLTRO-III) will be launched, starting in September 2019 and ending in March 2021, each with a maturity of two years. These new operations will help to preserve favourable bank lending conditions and the smooth transmission of monetary policy.

In short, according to Draghi, “we’re coming – and maybe we still are – in a period of continued weakness and pervasive uncertainty”. This is why the economic forecast has been revised downward – and why the ECB consequently eased its monetary stance.

Implications for Gold

What does it mean for the gold market? Well, more dovish Draghi is fundamentally bad news for the yellow metal. Many economists hoped that the ECB will join the Fed and will normalize its monetary policy. However, it is not going to happen anytime soon. The latest ECB decision should, thus, strengthen the US dollar against the euro – and gold – especially that the move was rather surprising.

You see, the greenback still appears as the only reasonable choice among the fiat currencies. Both the ECB and the Bank of Japan have not normalized its monetary policy. The People’s Bank of China has launched a fresh stimulus. The Bank of England pauses, preparing for Brexit. Instead of normalizing its monetary policy, the BoE has activated euro swap line, in order to shore up financial system in case of abrupt exit from the EU.

In such an environment, the Fed and its currency are the only game in town. It’s still the best looking house in a bad neighborhood. Indeed, the euro fell against the US dollar in the aftermath of the ECB monetary policy meeting, as one can see in the chart below.

Chart 1: EUR/USD exchange rate from March 7 to March 9, 2019

And the U.S. dollar index reached a new 2.5-month high. Unfortunately, what strengthens the greenback, hurts gold. Indeed, initially the yellow metal struggled following the ECB meeting. However, the selling pressure in the U.S. stock market helped the gold prices to rebound and go north, as the chart below shows.

Chart 2: Gold prices from March 6 to March 8, 2019

We acknowledge, of course, that the Fed pauses, but it still means that the divergence in monetary policies between the US central bank and the ECB – and the resulting gap between bond yields in America and Europe – will remain in place, supporting the greenback against the euro and gold. Moreover, stronger dollar should translate into lower US inflation – but, on the other hand, it also gives more leeway for the Fed to lean dovish.