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Euro Update And ECB Takeaways

Euro Update And ECB Takeaways

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

The primary focus Thursday for FX traders was the European Central Bank’s monetary policy announcement, which failed to impress. The decision to leave asset purchases and interest rates unchanged was widely anticipated but Governor Draghi provided zero insight into their policy plans. Theoretically, the lack of clear guidance should be positive for euro because it means the central bank has no immediate plans to ease. In light of the clear intentions of other central banks, the selling pressure was too strong and EUR/USD dropped to 1.0979. By the end of the North American trading session, we see EUR/USD still flirting with 1.10, which means there are as many buyers as sellers around this key level. While the euro could fall on the back of Friday’s PMI reports, we don’t see significant losses for the currency pair over the next month because the central banks of England, Japan, New Zealand, Australia and Switzerland are all expected to ease by the end of summer. So the best euro trades should be against the currencies of these countries and not necessarily the U.S. dollar.

We also compiled a list of our main takeaways from Thursday’s ECB meeting but the bottom line is Mario Draghi wants to see evidence of economic and financial markets deteriorating before taking additional action. Monetary policy will remain accommodative but it may be a while before the ECB eases again because it wants to see how data fares “in the coming months.” As we pointed out in our ECB preview, financial market conditions have not deteriorated significantly since Brexit. Draghi even said he’s satisfied with the market’s reaction and indicated that an early survey shows no major impact on inflation. He also sounded upbeat when he said he expects an ongoing recovery and pickup in inflation this year and next. The non-performing loans in Italy are a problem and Draghi supports a public backstop, but that is a EU — not ECB — decision.

ECB Takeaways

  • Leaves Rates Unchanged, Repeats they are “Ready and Willing to Act if Needed”
  • Risks to Euro Area Tilted to Downside and Inflation will Remain Low
  • Asset Purchases to Run Until At least March 2017, QE to Run Until Sustained Inflation Adjustment

But:

  • Too early to say what full impact of Brexit will be, waiting for new forecasts to help ECB assess situation in “coming months”

Right Now:

  • Satisfied with Euro Area Financial Market Reaction to Brexit
  • Early Survey Shows No Major Brexit Impact on Inflation
  • Sees TLTRO Helping Improve Loan Conditions
  • Q2 to be weaker than Q1, Export growth remains modest

What We Expect:

  • Ongoing Recovery, Increased Inflation Rates
  • Inflation to Pick Up this year and more in 2017, 2018
  • Worried about NPL, says public backstop possible at exceptional times

Sterling resumed its slide on Thursday on the back of softer retail sales numbers. Consumer spending fell -0.9% in June, the largest decline this year bringing annualized spending growth down to 4.3% from 5.7%. Excluding autos, consumption was just as weak with retail sales falling by the same amount. Although wage growth improved and employment is on the rise according to Wednesday’s labor-market report, consumers aren’t spending because they are nervous about the country’s outlook. The survey was taken between the end of May and beginning of July so it partially captures the impact of Brexit. Markit economics is releasing a special U.K. flash PMI report Friday, which is likely to show a significant decline. While Brexit may have had a limited influence on other countries, its impact on the U.K. is significant.

The U.S. dollar traded lower against most of the major currencies Thursday on the back of falling stocks and declining yields. The latest U.S. economic reports were mixed with manufacturing activity in the Philadelphia region slowing while jobless claims and existing home sales improved, beating expectations. We continue to expect the U.S. dollar to be a big winner as we head into a period of global easing and view pullbacks as buying opportunities. One of the big stories Thursday was the report that Bank of Japan Governor Kuroda does not see the need for helicopter money. This headline sent USD/JPY plunging to 105.42 until BBC clarified that this was from June, before Brexit. USD/JPY rebounded in response but failed to hold onto its gains as these conflicting headlines raised doubt about the prospect of helicopter money.

All three commodity currencies ended the day higher against the greenback including the New Zealand dollar, which shrugged off the RBNZ’s signal to ease. With that in mind, the rally in NZD was shallow and likely to be short-lived. The rise in gold and decline in the greenback helped the Australian dollar recoup part of Wednesday’s losses. Friday’s focus will be on the Canadian dollar. The currency received a boost from wholesale sales despite the decline in oil prices. Canada’s retail sales and consumer price reports are scheduled for release – economists are looking for spending to stagnate, which would be consistent with the deterioration in labor-market activity. Wholesale sales rose strongly, suggesting that demand is still there.

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