- Yesterday’s ECB meeting turned out to be a significant disappointment for those (including ourselves) looking for a weak inflation forecast to signal further easing from Frankfurt. The ECB kept all policy rates unchanged, did not introduce any non-standard measures and Draghi sounded more hawkish, than he did ahead of the meeting. With expectations geared up for at least some form of further easing, short-end rates ticked higher and EUR/USD jumped to the high 1.38s. With the lack of clear signals of further easing down the road we will probably see further short-term support to the euro and 1.40 is certainly in sight – albeit a few key resistance levels are in the way. In particular, we might see an unwinding of both speculative and hedging related short EUR/USD positions as the ECB meeting yesterday is regarded a “game changer” in the consensus.
- Longer term, with no obvious change in rhetoric and no hints of concrete further easing measures, it now appears much less likely that we will get the downside to rates needed to drive the level of EUR/USD to the mid 1.20s in 12M (even though our base case still is for the ECB to be pushed towards some form of easing in Q2). Consequently we have to reconsider the pace of downtrend in the profile in our current EUR/USD forecast when we publish new FX forecasts next week; it increasingly looks like a further uptick in the near term followed by a vague downward move. Notably, it is also worth keeping in mind that flows (euro-area current-account surplus and positive peripherals sentiment) and positioning are supportive of a stronger EUR near term.
- In matrix terms we are now moving away from 1.26 as our previous baseline 12M forecast (upper left-hand side corner) and down the first column; also, we could not rule out a row-wise move on Fed.
- But, we would be wary of projecting EUR/USD into the high 1.40s even without further ECB easing. First of all, it is clear that ECB’s so-called forward guidance should ensure that rates will be low for a very long period of time, and (notwithstanding recent US data weakness) Fed will still be hiking way ahead of the ECB. Second, the fact that the ECB assumes an unchanged EUR/USD in inflation projections highlight that significant upside in the cross would endanger a return to the 2% target in the medium term. Third, as we stressed in Euro Inflation Research 1: How the ECB makes its inflation projections the models employed by the ECB almost by default make inflation return to target – but that does not rule out that easing may be required to bring this about.
Danske Bank