Mario Draghi, president of the European Central Bank (ECB) on Thursday, July 25, 2019. Photographer: Alex Kraus/Bloomberg
© 2019 Bloomberg Finance LP
The European Central Bank (ECB) held interest rates unchanged at their meeting on July 25, with the main refinancing rate remaining at 0.0% and the deposit rate at -0.4%. However, the real indication of monetary intentions was revealed as ECB chief, President Mario Draghi stated their intentions to ease policy at a later date.
One should not be too surprised at the lack of action as the markets had been pricing the chance of a rate cut at no more than 50%. That said, the hint of future action led to a mixed reaction in the euro-U.S. dollar (EURUSD) exchange rate.
The currency pair fell to the lowest level since May 1, 2017, although a small bounce in the euro has been seen back to 1.1135 as of 08:20 Eastern on July 26.
There are several reasons for the Euro’s value sliding and the ECB indicating a willingness to add further stimulus.
The Business Climate Indicator (BCI) for the Eurozone declined to 0.17 in June from 0.30 in the previous month which was below market expectations of 0.23. That was the lowest reading since October 2014, as managers’ production expectations, as well as their views on overall and export order books and the level of inventories deteriorated.
Manufacturing production in the euro zone decreased 0.6% in May of 2019 over the same month in the previous year. Economic growth in the region was confirmed at 1.2% in the first quarter of 2019, the same as in the previous three-month period and yet GDP growth seems tepid when compared to the U.S. at 3.2%. Even the U.K. that is bedeviled by Brexit is growing at 1.8%.
The annual inflation rate in the Eurozone rose to 1.3% in June 2019, slightly above a preliminary and market expectations of 1.2% as costs advanced at a faster pace for food, alcohol & tobacco and services. However, the ECB has used all the weaponry in its arsenal at the major problems it faces, i.e. low growth and low inflation. The whole reason behind having an inflation target of 2.0%, curiously termed “price stability” is that a small level of price appreciation, encourages consumption and business investment.
Looking beyond the euro zone is not going to encourage any wider optimism as the European Commission summer economic forecast released on July 10 suggested that European Union (EU) is expected to expand by 1.4% and the euro zone by just 1.2%.
Forecasts for Italy remained challenging as its economy will see the worst growth rate in the whole EU, just 0.7%.
The foreign-exchange markets will now be shifting their focus onto the U.S. Federal Reserve as the Fed is widely expected to cut rates at their meeting next week.
There is a view that the prospect of a declining interest rate differential between the U.S. and the euro zone means that the euro could be ready to stage a recovery in the form of a relief rally.
I think that might prove short-lived as the second-quarter GDP growth figures have just been released for the U.S. These came at 2.1% cf. an expectation of 1.8%. This was the last economic data point that could have impacted the Fed’s decision next week. I do not think the need to cut rates in the U.S. is as pressing as it is within the euro zone.
That to me suggests there will a medium-term decline in the level of EURUSD and I sense a fall as far as 1.0344 by year-end cannot be overlooked.
