EUR/USD Rate is a Sell say CitiFX as EURUSD Holds Onto Most of ECB Gains

The European Central Bank's President Mario Draghi sparked a spectacular rally in the EUR/USD conversion when he discounted the prospect of further agressive easing in 2016 and 2017.

• CitiFX: Sell into strength around 1.13 as markets have overreacted
• Euro could still go higher short-term
• Forecasting another ECB rate cut in the future

The euro to dollar exchange rate closed the week at 1.1153 having held onto the lion's share of the previous day's post-ECB rally.

The currency pair ended the ECB's March policy event sharply higher despite the central bank delivering a confident set of monetary policy measures aimed at boosting Eurozone economic growth.

The euro initially fell sharply on the news the ECB added a further €20 billion to the monthly QE budget along with lowering rates, introducing a second version of TLRTOs and allowing corporate debt to be used as part of its portfolio of investments.

The move lower was oiled by the announcement of a 5 basis point cut to the refinancing rate and a 10 basis point cut to the deposit rate. The ECB is now effectively paying banks to borrow money from them, in the hope that they will lend the money onwards.

There was also news that non-financial entities with investment grade debt would be eligible for inclusion in the ECB's easing programme.

The euro to dollar rate hit a low at 1.0822.

Press Conference Sparks Impressive Euro Recovery, Gains Held

At the ECB's press conference we saw a specatcular turnaround in fortunes for the single currency.

Mario Draghi emphasized the point that the ECB were unlikely to reduce rates any further into negative territory effectively putting a bottom on interest rates at their current level.

He said that the bank had considered using a tiered rate system like that of the Bank of Japan, in order to lessen the negative impact on banks, however, in the end they decided not to. 

The reason being was tiering was not compatible with the variety and complexity of the Eurozone's banking industry. No two banks are the same argued Draghi.

The euro rose rapidly following these comments, to reach highs of 1.1218, the exchange rate has pulled back a little on Friday but the vast majority of the gains are being held with the rate quoted at around 1.1114.

Sell the Euro on Rallies: Citi

Analysts at the world's largest foreign exchange dealer - Citibank - sense something of an overreaction in the euro.

Citi do concede that positioning played a big part in the euro's recovery, as it did in December, whereby traders betting heavily against the euro are forced to close their negative bets as the market moves agressively against them. 

But, Citi sense a fundamental overreaction to Draghi's comments, "markets ignore the qualifying comment that the ‘no further rate cut’ stance could change in light of new information and low rates will continue well after the asset purchase program ends."

Markets also seem to be downplaying the significance of the 4 new TLTROs in adding stability to the banking system via more liquidity provisions and hence addressing risk premia concerns on financials.

"The fact that greater asset purchases will ultimately help to weaken EUR through the flow channel though it may require President Dragi to clarify the breakdown of QE," say Citi.

Citi warn that further short-covering to 1.13 is now a distinct possibility as the move higher could have further to run.

Yet, "there is no denying that the ECB has over-delivered on the stimulus front and the medium term outlook is now a firm ‘sell on rallies’ to levels approaching 1.1300."

Another Rate Cut Will Come

So confident are analysts at Citi that markets have misread Draghi's comments about future rate cuts that they are sticking with their call for another deposit rate cut to -0.50%.

However, the timing of the move has been pushed back from September 2016 to March 2017.

Citi economists also expect further enhancements to the TLTROs (the ECB’s longer term lending facilities to banks to add liquidity) by cutting the ECB’s marginal lending rate to banks as well as a further six-month extension to its asset purchases program likely to be announced at the June 2 meeting.