Week in FX Europe – ECB Pulled The Trigger And Kept The Door Ajar

He did it, Draghi turned on the lights when the market least expected. The ECB cut its refi-rate by -0.25%, to just above zero on Thursday. Perhaps more importantly and because of the global benign inflation phenomena, the Euro policy makers kept the downward bias to its forward guidance. In other words, the door was kept open to take Euro deposit rates into negative territory.

Negative deposit rate are generally tied to a more deflationary economic backdrop, the late 90’s in Japan is a good example. Europe is not there yet according to Draghi. During yesterday’s press conference he indicated that there is no danger of deflation, although policymakers expect a prolonged period of low inflation.

By breaking its own conservative mold, the ECB’s unexpected rate announcement indicates a more proactive approach from policymakers to address the heightened concerns across Europe. Any further downside movement from an already fragile recovery combined with weak inflation is likely to be accompanied by further ECB action now that they are in “proactive gear.”

The surprise ECB cut has steepened the 5/30’s curve to ten-year highs. Can this move much further? Fixed income dealers thinks the spread looks rich, and without negative deposit rate cuts the top could be close. However, expect risk premiums to be applied for Q1 Eonia 2014 meet.

The EUR has not backed away from it initial -1.5% fall, aided by Friday’s NFP surprise. Last February was the last time that the ECB was so blatantly dovish. The EUR is expected to become an increasingly attractive funding currency for the remainder of this year. For now, and until investors are told otherwise, the Federal Reserve will continue to try to communicate that its policy will remain loose, presumably under the guise of transparency and through tapering environment conditions. That ought to keep rates low for a considerable length of time. Under this scenario, the EUR should be capable of finding some support close to the 1.3000 levels.


WEEK AHEAD

* CNY New Yuan Loans
* GBP Consumer Price Index
* GBP Bank of England Inflation Report
* JPY Gross Domestic Product
* EUR German Gross Domestic Product
* EUR Euro-Zone Gross Domestic Product s.a.
* USD U.S. Senate Banking Committee Confirmation Hearing for Yellen
* EUR Euro-Zone Consumer Price Index

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell