News & analysis

The rate cutting genie is out of the bottle for the European Central Bank after Mario Draghi this morning mentioned that further cuts in the policy rate remain part of ECB’s toolkit.

A full ECB rate cut is now priced in by futures markets for 2019 after Draghi showed his concerns about the persistently low inflation in the Eurozone and the lingering risks to growth, especially stemming from weak manufacturing and export conditions.

Also, the ECB President mentioned there is “considerable headroom” regarding the Asset Purchase Program, indicating the ECB armoury is far from exhausted.

This opens the trapdoor to lower levels on EURUSD, while especially high yielding currencies that are used in carrying trades with the euro as a main funding currency, like ZAR and TRY, may profit.

Even as the Federal Reserve cuts interest rates as well, ECB rate cuts imply that the rate differential will remain in favour of USD denominated assets, keeping EURUSD pinned in a lower range for the foreseeable future.


Graph: EURUSD takes a dive and heads for two-year lows

Although the exchange rate is not an explicit policy objective of the ECB, the collateral damage done to the single currency by speculating on further rate cuts is likely secretly welcomed by the high men of the ECB’s governing council.

If the domestic economy fails to produce the inflation needed for the ECB to reach their mandate, there is always imported inflation that can jump to the aid of the Frankfurt-based technocrats.

Finally, setting such dovish tones may catch Draghi’s potential successor in a web of easing policies that have just started, or are about to be implemented.

Even if the next in line will lean more to the hawkish side, Draghi’s last deeds as ECB president appear to be to solidify the dovish policies to the extent there is no escaping from this.

The fact that Draghi is resigning while having his dovish legacy felt may be the main message taken from today’s communications, which implies that even a more hawkish new ECB president will have to take some time to untangle him/herself from Draghi’s dovish web before further tightening can even be put on the agenda again.


Author: Bart Hordijk, FX Market Analyst at Monex Europe.