Forward Guidance: a Draghi on the euro

“Forward Guidance” is the buzz word of the day, the BOE used it in its statement earlier, and now ECB President Draghi has joined the party and ditched the prior ECB policy to never pre-commit to future policy decisions. In his statement today Draghi said that “our monetary policy stance will remain accommodative for as long as necessary”, which was unanimously decided by all policy members.

After saying that monetary policy will remain accommodative for an extended period, Draghi would not be pinned down on exactly how long policy will remain accommodative; e.g., 6 months, 12 months etc. Added to this, at this stage there are no economic thresholds accompanying the guidance, so we need to wait and see if they may be added in the future. Thus, the details surrounding the ECB’s forward guidance policy are still cloudy, which could add to market uncertainty and weigh on the EUR in the coming days.

EURUSD fell sharply as Draghi was speaking and lost its grip on the 1.30 handle. The low so far has been 1.2880, a noted level of support that we mentioned in our ECB preview. Although Draghi’s comments weighed heavily on the single currency, he was very clear that the ECB does not target the exchange rate. However, we believe that this shift in stance will weigh further on EURUSD in the near term and we could see back to the sub-1.28 lows from late March as the ECB’s accommodative stance is in stark contrast to the Federal Reserve, who is planning to taper its asset purchase programme in the coming months. Post the ECB meeting the interest rate differential between Germany and the US has plunged further, which is EUR negative in the medium term (see chart below).

ECB and BOE: picking up the slack for the Federal Reserve?

During the press conference, Draghi was asked if this shift in policy towards forward guidance was due to changes in policy at the Federal Reserve. Unsurprisingly, he dismissed this and said the ECB only acts in accordance with Euro-area jurisdiction. However, it does seem strange that after the Fed mentioned the possibility of tapering its asset purchases last month, the ECB and BOE have both come out and pledged to keep monetary policy accommodative for the long-term. Are they potentially picking up the slack for the Federal Reserve?

Regarding interest rates, Draghi said that rate cuts are not constrained by a lower bound at 0.5%, suggesting that rates could be cut further, and he also said the ECB was keeping an “open mind” on negative deposit rates. Thus, if the economy does not pick up we could see further rate cuts, which is also adding to the bearish bias weighing on the EUR.

Overall, it has been a memorable day for monetary policy in the Eurozone and the UK. Forward Guidance is the future of monetary policy this side of the Atlantic, and with growth rates in the Eurozone still so weak, we could see accommodative policy for some time. Thus, 1.3050-75, a cluster of moving averages and a key resistance zone, could be a medium-term top for this pair.

Source: Forex.com

04.07.2013