Rumours of an Unhappy ECB Halts the Euro's Rise

The Euro exchange rate complex was put under pressure following the release of a report that claims key members of the European Central Bank (ECB) believe markets have completely misread the message delivered at their March policy meeting.

The meeting's policy statement was perceived by markets to be more optimistic about the economic outlook than they had expected, which led to the Euro rallying and Eurozone bond yields increasing as traders anticipated the ECB withdrawing its monetary easing programme over coming months.

However, sources close to the ECB say the extent of the recovery in the Euro and the rise in bond yields was unintended – and unwarranted.

A news report carried by Reuters said the ECB was now wary of making further changes to its policy message next month.

It said the ECB felt the markets had over-interpreted president Mario Draghi’s comments at the March 9 meeting and that, while the current level of bond yields was acceptable, further increases would be problematic - especially for nations in the eurozone “periphery”.

This does not sound like a bank that is looking to start restricting its monetary easing programme which has over time devalued the Euro.

The Euro came under pressure on the notion that the ECB will look to maintain a message that it is in no way looking to embark on any kind of policy change that would lessen support to the Eurozone economy.

“ECB Council members are leaning against the market’s inclination to price the possibility of rates being slightly higher by year-end,” says Kit Juckes at Societe Generale. “The net effect is the ECB has managed to cap yields and the Euro. Volatility-junkies are not amused.”

Since the news markets have readjusted with the Euro falling back below the key 1.0800 level to lows of 1.0732 and Eurozone government bond yields falling back down again.

The Pound to Euro exchange rate has meanwhile appreciated on the news to 1.1586.

Analysts at Italian bank UniCredit think the ECB is merely using verbal intervention to keep the Euro cheap and high Eurozone peripheral bond yields down.

The ECB has good reason to talk down the currency as the recent rise in the Euro could start to hurt exports which have been one of the main ways the region has been digging itself out of the great recession.

The rapid rise in bond yields, particularly in the periphery, where borrowing is already disproportionately more expensive than in the core, may also have spooked the ECB, and, according to UniCredit prompted them to make a verbal intervention.

The story about the ECB governing council being surprised by the rapid recovery in financial markets due to the meeting was leaked by “six sources close to the ECB governing council” according to the original Reuters exclusive, and may well have been a ploy to push markets back down.

Even though the ECB may want to play down the extent of their change instance at the March meeting, there were clear and material changes to both their forward guidance, Mario Draghi’s press conference and the tenor of their deliberations, which make some of the market reaction proportionate.

“Yesterday’s headlines about the ECB becoming wary that the policy message in their last press conference was over interpreted,” they say, adding:

“We view these comments as aimed mostly at curbing the pace of yield rises (and hence euro appreciation) rather than reversing the course. Therefore, some short-term headwinds have developed, but we maintain our constructive view predicated on the euro area cyclical upswing currently underway and the market turning progressively cautious on the USD.”

The assumption, therefore, is that the pull-back is merely corrective rather than a complete reversal, and therefore offering a good opportunity to buy the Euro.

Was the ECB’s meeting message decidedly more optimistic?

The argument that markets overreacted to the ECB’s March statement and Mario Draghi’s press conference is questionable given the facts remain that the ECB did come across as guardedly positive about the outlook.

The statement witnessed the removal of the phrase that if warranted, “the Governing Council will act using all the instruments available with its mandate,” which Draghi explained was due to there “no longer being a sense of urgency to take further action,” according to TD Securities.

There was no discussion of an extension of the ECB’s cheap financing programme called TLTRO II, which officially ended in March, and this was put down to an improved climate.

There was also a cursory discussion about removing the reference to lower interest rates in the ECB’s forward guidance, given that the Governing Council did not anticipate that interest rates would need to be reduced further.

Draghi also mentioned the possibility of raising interest rates whilst tapering QE, not after as had been expected.

ECB Chief Economist Peter Praet has also been in damage control mode since, arguing that there is "strong logic" backing up the guidance, which stipulates that asset buys would have to end before any interest rate hike.

Given the strong evidence the ECB changed its stance quite substantially, it seems possible, that UniCredit may be right and the ECB could just be trying to talk the Euro down to protect exporters.

Eurozone Inflation Data on Friday to be Key for the Euro's Outlook

The next major release for the Eurozone is Inflation data released on Friday, March 31 at 9.00 GMT, and this could have a significant impact on the debate.

A higher inflation print – particularly Core Inflation – will make it more likely the ECB will normalise policy sooner than previously expected and probably see a rebound back higher in the Euro after the overnight dip. 

Headline inflation is forecast to show a 1.8% rise in March year-on-year.

Analysts at TD Securities, however, think that there is a chance Eurozone (headline) inflation will slowdown in March:

“We look for inflation to ease off in March after Feb’s strong 2.2% (yoy) print, as the contribution from oil prices declines due to both lower base effects and their outright decline in March, and the timing of Easter leads to a further dip.”

If so then the Euro could extend its losses.

Preliminary data for Germany, Spain and Belgium suggest that eurozone inflation dropped back to levels well below 2% in March.

HICP inflation in Germany declined to 1.5% down from 2.2% in February when markets had forecast a rise of 1.9%.

In Spain it dropped to 2.1% from 3.0% and Belgium recorded a decline to 2.3% from 3.0%.

These inflation data are another factor in the Euro's current underperformance as it shows the ECB will not be keen on withdrawing its stimulus any time soon.