Having seen markets anticipate and dissect every word that European Central Bank (ECB) President Mario Draghi has uttered over the last few months—not least the uneventful speech at the Federal Reserve Bank of Kansas City’s annual economic policy symposium at Jackson Hole, Wyoming—we’ll be watching his September press conference with some trepidation.
What could he say that would avoid upsetting markets?
Indeed, managing diversified portfolios against a backdrop of elevated equity valuations and no shortage of potential catalysts for a rise in volatility seems to us to be easier than the challenge facing the ECB president.
The ECB is entering a crucial phase of its battle to secure eurozone price stability, as the economy improves but inflation remains stubbornly below the 2% target.
With headline eurozone consumer price index inflation at 1.5% year-over-year in August, the ECB has felt able to declare victory over deflation. However, core inflation remains weak and the ECB is still a long way from achieving its objectives.
Hence, the ECB Governing Council has so far maintained its guidance that key interest rates would remain at present levels for an extended period of time, and well beyond the end point of its quantitative easing (QE) programme. Although the council now appears to be reviewing the approach for scaling back QE, its end is neither imminent nor certain, in our opinion.
The euro’s strength was prompted by market analysts trying to explain the currency movement in relation to comments from the central bank, against an economic environment that had shifted in a much more euro-supportive direction.
However, the shift in economic sentiment may owe as much to developments on the other side of the Atlantic than anything in the ECB’s control. Nonetheless, market attention could focus again on attempts by the ECB to “correct” market misinterpretation of the ECB’s own comments.
We believe the ECB would prefer to avoid any further appreciation of the euro, particularly while inflation is still running well below target.
Indeed, we may already have reached the point where euro strength has tightened monetary conditions sufficiently to change the outlook for growth in corporate earnings and the appropriate path of monetary policy.
Therefore, the question is whether the ECB can do anything to control the euro’s rise?
The euro might appreciate still further, having risen to the highest level since early 2015. Indeed, this appreciation has taken its value against the US dollar to levels not seen since the start of the ECB asset purchase programme, prompting further speculative investments in the single currency, taking them to multi-year highs.
It is interesting to question whether such a move, originally driven by an expectation of a tapering of bond purchases, might ironically lead to an extension of QE.
Mario Draghi may contemplate following his Jackson Hole approach—of saying nothing about the euro. The futility of trying the talk down a strong currency is almost as well documented as failed attempts at intervention in support of a weakening exchange rate.
The Swiss National Bank (SNB) has recently started to gain some relief from a highly valued Swiss franc, in part as a result of the euro’s appreciation. However, the volatility that was set off by the SNB’s earlier failed attempt to halt the franc’s appreciation is still fresh in the memory of European central bankers. Verbal intervention to halt the rise of a currency is tricky and often the best that you can hope to achieve is to slow down the process.
However, Mario Draghi is an inflation-constrained central banker who doesn’t want to say the wrong thing and to “avoid sending signals that could be prone to over-interpretation” (as the minutes of the previous Governing Council meeting in July highlighted). While not talking about the euro may be an option, it will remain the elephant in the room.
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