The Euro-Dollar Rate: ECB Strategic Review Portends Year of Inaction Absent an Economic Shock

- EUR retains soft tone after ECB holds rates and QE.

- ECB has launched strategic review of policy stance.

- But markets must wait until end-2020 for its outcome.

- Focus on CPI target, policy toolkit, analytical practice...

- ...Financial stability, environmental sustainability, jobs.

- Implication: new policy info limited until year-end 2020.

- Price action comes as coronavirus concerns lift USD.

Above: File image of Christine Lagarde. Image © IMF. Image reproduced under CC licensing conditions.

- EUR/USD Spot rate: 1.1068, down 0.23% today

- Indicative bank rates for transfers: 1.0701-1.0779

- Transfer specialist indicative rates: 1.0923-1.0989 >> Get your quote now

The Euro extended declines Thursday after the European Central Bank (ECB) launched a strategic policy review that promises a 2020 year of inaction on interest rates, absent an economic shock that necessitates further stimulus.

ECB President Christine Lagarde says the Eurozone economic outlook appears to be stabilising albeit that risks are still tilted to the downside. She also noted a recent uptick in inflation before reiterating the ECB's long-held conention that price growth will one day converge with the target of "close to but below 2%."

However, the newly-installed policy chief also said the sluggish Eurozone economy will still require a "highly accomadative" monetary policy for the foreseeable future before reassuring markets that the bank stands ready to recalibrate its current policy stance as appropriate. 

"We’re still way too early in Lagarde’s tenure to do anything major – including changes in guidance (probably an H2 story), asset purchases (a 2021 story) and alterations to tiering/TLTRO’s," says Bipan Rai, North American head of FX strategy at CIBC Capital Markets. "Markets are quiet to start the NA session. There is a slight risk off feel as China makes travel restrictions in certain cities due to the Coronavirus. The trade weighted USD is little changed."

Above: Euro-to-Dollar rate shown at hourly intervals.

It goes almost without saying that the ECB left all interest rates unchanged, in line with expectations. The deposit rate was held at its new low of -0.50% while rates on 'main refinancing operations' and the 'marginal lending' facility remained unchanged at 0% and 0.25% respectively.

The ECB also confirmed the purchase of a second €20 bn installment of bonds as part of the quantitative easing (QE) announced in September. QE will continue until "the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics."

September 2019's decision to cut rates further below zero was met with concern not only in the market but also within the corridors of the Franfurt-based institution, concern that may have contributed to Lagarde's decision to make a strategic review of the policy approach her first major task as head of the bank.

Above: Euro-to-Dollar rate shown at 4-hour intervals.

Details of the scope and timetable of the strategic review were revealed Thursday. They appear to have left Euro 'bulls' slightly frustrated.

"The quantitative formulation of price stability, together with the approaches and instruments by which price stability is achieved, will figure prominently in this exercise. The review will also take into account how other considerations, such as financial stability, employment and environmental sustainability, can be relevant in pursuing the ECB’s mandate. The Governing Council will review the effectiveness and the potential side effects of the monetary policy toolkit developed over the past decade," the ECB says.The 

Many observers expect the review to pave the way for the ECB to keep rates at or near to current levels for years to come, and for it to also insert the bank into the climate debate and policy process. However, and other than the obvious, the only thing that can be said for certain in relation to it is that the pending period of reflection will prevent the ECB from changing its policy stance absent an economic shock that neccesitates additional stimulus.

Above: Euro-to-Dollar rate shown at daily intervals.

The Euro-to-Dollar rate was quoted 0.23% lower at 1.1068 following the release of the review details at 14:30, after buidling on an earlier 0.09% loss.

Thursday's losses extended as the Dollar strengthened at the beginning of the North American session. The Dollar strengthened in part because of mounting fears about the possibility that China's coronavirus could lead to a pandemic.

Meanwhile, the EUR/GBP rate was 0.04% lower at 0.8437 after reversing an earlier gain, which denotes modest weakness in the single currency.

In other words, the decline in the Euro-to-Dollar rate may have been driven as much by Euro weakness as it was by Dollar strength.

"A sense of disappointment that policy is effectively going to be unchanged for the coming year saw a further drift lower in rates (10yr Bunds slipped a further -2bp towards -30bps) and EUR (EUR/USD dipped to 1.1060) but this also occurred as broader market sentiment wilted with a broader bid tone in global bonds," says Tim Riddell, a London-based macro strategist at Westpac.