Euro Under Pressure as ECB Cuts Interest Rates at March Meeting

Fireworks for the euro as the European Central Bank delivered some agressive policy measures only to see the work undone over the duration of the press conference that followed.

• Draghi snatches defeat from the jaws of victory, offers no hint of further cuts, euro seen recovering agressively
• Volumes of euro trades some 250% higher than the recent average as euro zone rates spike
• ECB had initially sent euro lower on surprise 5bp cut to refi rate, deposit rate cut 10bps, as expected
• Quantitative easing expanded €20bn, more than €10BN forecast, now at €80BN

Volatility in the euro exchange exchange rate complex exploded as the European Central Bank (ECB) delivered its latest set of policy measures which included further cuts to the basic interest rate.

After initially falling on news that the ECB had cut rates and expanded quantitative easing more agressively then expected, the euro quickly swept higher on comments made during the press conference following the announcement.

The move forced the EUR/USD conversion to highs at 1.12, its best levels since mid-February.

The pound meanwhile broke below the key 1.2850 support zone and threatened to fall back to its February lows.

24 hours later and markets realise they may have overreacted.

We are seeing the shared currency settling back to lower levels allowing the pound to break higher into its 1.2850-1.30 range once more.

The euro / dollar exchange rate is meanwhile looking ready to break below 1.11 again.

“EUR and euro rates appear to have significantly overreacted to selective parts of the ECB commentary,” say CitiFX in a client brief, “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.”

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"Having learned some harsh lessons back in December, the ECB was never going to underwhelm the markets and has thrown the book at the problem. Mario Draghi 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," says Alastair McCaig at IG.

The determination behind these actions had the effect of forcing the euro to dollar exchange rate sharply lower and sent equities soaring.

Euro Rockets Higher

"But before too much congratulatory backslapping could take place in Brussels, the ECB president managed to trip himself up in the following press Q&A session," says McCaig.

Draghi admitted that pushing interest rates ever-lower into negative territory was an unlikely policy expectation in his view as he questioned the effectiveness of such measures.

Euro strength was surprisingly agressive in response.

"Comments from ECB’s Draghi during the press conference that he doesn’t see any need to reduce rates further, resulted in a turnaround in sentiment pushing EUR/USD above 1.11 before it eased somewhat," says Gorgette Boele at ABN Amro.

CitiFX note volumes traded were some 250% higher than the recent average as traders took an outsized interest in the market.

Markets are an insatiable beast it seems, wanting more and more, and even a hint of confidence in the press conference appears to have stimulated buying interest in the euro.

The ECB is facing a tricky balancing act: on the one hand, the central bank wants to leave the door open to cut rates further if needed, while on the other hand they want to signal to the market that they do care about side effects of easing measures on banks’ profitability.

"Overall, the bar for cutting deeper into negative territory now appears somewhat higher than we had previously thought," says Marco Valli, Chief Eurozone Economist with UniCredit Bank. "Ultimately, we regard this as good news, although the near-term price for the ECB to pay is a stronger currency: from the intraday low, the EUR-USD is up three figures to above 1.11."

The run-up to the ECB decision was notable in that markets consolidated with a slight negative bias on the single currency.

Latest Reactions

CitiFX: The almost 4 big figure post ECB spike in EUR, after initially dipping to a 1.0821 low, coupled with rising euro rates (German 10Yr Bund yield almost doubling to 0.306%), appears to be a significant overreaction."

Marco Valli, Chief Eurozone Economist at UniCredit Research: "In the Q&A session, Draghi somewhat weakened this message when he claimed that the idea to adopt a tiered framework for the deposit facility was eventually dropped mainly to avoid signaling that there is no lower limit on rates."

Jonathan Loynes, Chief European Economist at Capital Economics says, "There is no guarantee this 'bazooka' will be any more effective than previous ones in securing the strong and sustained growth required to eliminate the threat of deflation in the currency union and allow perohperal countries to tackle their debt problems. The ECB has belatedly delivered, but it can't work miracles."

Richard Kelly, Head of Global Strategy at TD Securities: "Surprisingly they have cut the refi rate by 5bps to 0%. That is less consequential but a tip of the hat to doing everything the can on rates and making liquidity a little cheaper."

This is a Formidable Package

The last 'live' meeting in December saw the EUR/USD exchange rate rocket higher when the Bank failed to deliver the degree of action markets were expecting.

Markets had forecast a 10 bps cut in the deposit rate which they got as expected.

It was news that the ECB made some changes to its QE programme that initially weighed on the euro.

According to Reuters consensus expected monthly purchases of at least EUR 70 billion to be announced, 10 BN more than the current rate.

The purchases were increased by 20BN, and importantly, the ECB announced, "investment grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets that are eligible for regular purchases.

Strategically Speaking...

CitiFX are looking to sell the euro / dollar rate is now a sell on rallies:

"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."

Heading into the ECB event we agreed with those in the analyst community who were biased in favour of a lower euro.

We reported ING suggesting the euro is going to fall as the ECB will provide the necessary stimulus to push the euro lower, they were right.

ING saw falls of around 1.5% in the EUR to USD conversion on the back of policy measures. What they could not have foreseen were the comments from Draghi.

Societe Generale meanwhile reckon the ECB is running on empty having exhausted the policy tools at its disposal.

Soc Gen's Analyst Alvin Tan suggested any dips in the EUR/USD should be considered buying opportunities.