Lower Euro Exchange Rate is on the ECB's Wish-List

The European Central Bank could agressively target the euro at their March meeting having become frustrated with the exchange rate's strength.

The euro has been under pressure against the US dollar for seven of the last seven days with the latest leg in the move lower following the release of the ECB's January policy meeting minutes.

What the markets have heard is that decision-makers are increasingly focussed on the value of the euro which has lead to speculation that policy moves will be more readily deployed to target the exchange rate.

The euro to dollar exchange rate has struggled to find buying interest since the release of the minutes, even as stock markets sell off; conditions that are usually ripe for EUR advances.

"The sell-off was sparked by the ECB minutes and while we are not surprised to see the euro continue to fall, the reaction was larger than we anticipated since everyone knew the minutes would be dovish. However it seems investors needed validation," says Kathy Lien, analyst at BK Asset Management.

We hear that many strategists who were previously betting on a return of strength are now getting a little disheartened.

There are no such worries with regards to the euro to pound sterling rate though, nothing seems to be able to arrest the decline in GBP at present and the trend for further gains appears to be something not even the ECB can stop.

ECB Unhappy with Euro's Strength

We know the ECB doesn't like the euro being as strong as it currently is, and the currency came in for a special mention opening the door to potential action specifically targetting the exchange rate:

“Risks were considered to remain on the downside and related, in particular, to heightened volatility in financial and commodity markets and increased uncertainty about the economic outlook for emerging market economies.

“Euro area net export demand was also seen to be influenced by developments in the euro exchange rate.

“Since the last monetary policy meeting the euro exchange rate had been relatively stable against the US dollar, but it had appreciated against other currencies, in particular those of emerging market economies.”

Markets are taking caution already.

Bank of America say that long as risk-off continues they expect EUR to remain supported.

But, "we would be tactically short just ahead of the March ECB meeting, as we expect more easing, but will be quick to take profits."

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Low inflation and Global Uncertainty Could Also Prompt ECB Action

Apart from the elevated euro, two additional reasons for reconsidering its monetary policy stance given by the ECB were persistently low inflation expectations and the impact of global risk premia. 

The fall in inflation expectations was put down to the collapse in the price of oil:

“Concerning inflation expectations, survey and market-based indicators had declined since early December 2015.

“These downward revisions from the previous SPF round mainly reflected oil price developments and continued subdued labour costs.”

The minutes also point out a clear ongoing correlation between oil and euro-zone inflation:

“Euro five-year forward inflation-linked swap rates five years ahead appeared to be moving in line with commodity prices again.”

There is Also the Chance the Bank Underwhelms

With oil recovering on moves by the major producers to ease back on production, we wonder if this will be such an issue in March. If oil prices rise we see the prospect of the ECB scaling back their ambitions.

Indeed, on growth, the region continues at a “moderate pace” suggesting the Bank is happy with the current trajectory:

“In the euro area, real GDP had continued to grow at a moderate pace, rising by 0.3%, quarter on quarter, in the third quarter of 2015, largely driven by private consumption on the back of higher real disposable income for households, while investment dynamics remained weak.”

Problems with bank-lending and transmission appear to be easing:

“Euro area loan dynamics had continued to improve gradually in November 2015 for both firms and households.

“The annual growth rate of loans to non-financial corporations (adjusted for sales and securitisation) had increased to 0.9%, up from 0.6% in October.

“The annual growth rate of loans to households had increased further, to 1.4%, after 1.2% in October.”

The Eurozone Economy Remains Robust

Nevertheless, there were also signs that the ECB may be happy with their current policy settings noting overall the region’s economy was seen as resilient to outside shocks.

Take note - often markets and analysts get frustrated when the ECB fails to deliver hefty changes to policy, but too often they have ignored the positives in the communications preceding decisions, such as this:

“Views were exchanged on the resilience of the euro area to potential negative shocks from the global economy.

“On the one hand, the euro area had thus far demonstrated a relatively high degree of resilience, as reflected in confidence indicators available up to the year-end.

“On the other hand, euro area financial markets had been affected by the recent increase in global risk aversion and some concern was voiced that global shocks could again have different effects on the financial markets of individual euro area countries.”