Euro Cheers as Cautious Optimism Seeps into ECB’s Rhetoric

- EUR/USD in brief rally as EUR cheers ECB's cautious optimism.
- ECB says medium-term economic risks now "more balanced."
- And maintains pledge for "significantly faster" PEPP purchases.

Above: File image of Christine Lagarde. Image by Dominique HOMMEL. © European Union 2019 - Source: EP

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The Euro-Dollar exchange rate briefly led a resurgence of the single currency complex Thursday in an apparent response to the April monetary policy statement of European Central Bank (ECB) President Christine Lagarde, whose words conveyed a creeping sense of cautious optimism.

President Lagarde said after the bank’s April decision, in which the parameters of all policy instruments were left unchanged, that while near-term economic risks remain tilted to the downside the medium-term outlook has brightened amid progress expanding Europe’s vaccination programme.

Lagarde described those medium-term risks as “more balanced” when leading a press conference following the decision, against a backdrop of rising Euro exchange rates.

Euro exchange rates were a mixed bag of performances heading into the event before the single currency briefly turned the tables on major counterparts to outperformer on the day mid-way through Lagarde’s address.

“Judging by the headline numbers, the central bank is in a decent position. It still has a significant portion of the PEPP left between now and March 2022‚ and so far markets seem uninterested in testing the ECB’s commitment to use this bazooka,” says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics.

The ECB reiterated its March commitment to carrying out government bond purchases under its Pandemic Emergency Purchase Programme at a “significantly higher pace” this quarter, although the bank has not yet needed to make good on that thanks to calmer conditions in bond markets.

Above: Euro-Dollar rate shown at hourly intervals alongside EUR/GBP (green).

The ECB has allocated €1.85 trillion to Europe’s PEPP programme and repeatedly pledged to carry out its weekly purchase at a quicker pace or in larger quantum in order to ensure supportive conditions for the Eurozone’s economy.

Weekly purchases under the PEPP programme have barely increased over recent weeks although this period has coincided with declines in longer-term American bond yields, which had risen sharply in late February and March and in the process dragged other sovereign yields higher too.

“The dollar hovered near seven-week lows against the euro after the ECB left monetary policy unchanged,” says Joe Manimbo, a senior market analyst at Western Union Business Solutions.

It goes almost without saying that policymakers in Frankfurt decided this week that they would leave rates charged or paid on main refinancing operations, the marginal lending facility and bank's deposit facility unchanged at 0.00%, 0.25% and -0.50% respectively this month.

“The Governing Council expects the key ECB interest rates to remain at their present or lower levels until it has seen 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,” the ECB reiterated on Thursday.

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This is all after rising yields tightened “financial conditions” in the Eurozone just as the ECB was seeking to make them as accommodating as possible, hence theMarch pledge to buy more bonds, which would’ve force yields lower in the absence of market-led declines.

Though it’s the creeping sense of albeit cautious optimism in the bank’s rhetoric which may have mattered most to the Euro following a torrid quarter in which continental economies appeared to be at risk of falling months behind in the race to vaccinate and reopen businesses.

“The EUR could draw some influence from the press conference that followed today’s ECB policy announcement. That said, the position of US treasury yields has been the overwhelming influence for EUR/USD this year and with these currently on the back foot, there is potential for EUR/USD to sustain levels above 1.20 in the near-term,” says Jane Foley, head of FX strategy at Rabobank.

Foley and the Rabobank team see the Euro remaining vulnerable to corrections lower over the coming months, but have acknowledged the Euro-Dollar rate’s recapture of the psychologically significant 1.20 level, which it has so-far sustained.

Above: Euro-Dollar rate shown at weekly intervals alongside EUR/GBP (green).

Coronavirus vaccinations have picked up in Europe and are expected to rise further in the months ahead, enabling a better spread and more sustainable easing of ‘lockdown’ restrictions that were ratched up in recent months in response to a third wave of infections.

This could potentially be supportive of the Euro-Dollar rate over the medium-term, although it also matters that the U.S. Dollar has rolled over concurrently with American bond yields in recent weeks, as this is supportive of many ‘risk’ currencies including the Euro.

Dollar declines have been encouraged by Federal Reserve (Fed) monetary policy, which is to leave interest rates near to zero until its 2% inflation target has been over-achieved and for an unspecified period of time.

This policy, and especially when combined with the robust and inflationary U.S. economic outlook, is corrosive of the yield returns earned by investors who hold the Dollar and is threatening to drive an increase in hedging ratios among foreign investors in U.S. stock markets.

Many of those investors are domiciled in the Eurozone and would need to sell the Dollar in exchange for Euros in order to protect returns against any Dollar depreciation.