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Talking Down the EURO is About the Only Thing the ECB Can Do at This Point

In June the ECB announced a number of stimulative measures including lowering rates and announcing a Targeted Longer Term Refinancing Operation or TLTRO that would take effect starting on
Greg Michalowski, Founder and President of GregMikeFX.com, a foreign exchange consulting company, and author of Attacking Currency Trends (WIley Publishing) has 28 years experience as a trader and financial analyst. His career began at Citibank New York and later at Citibank London where he was a Vice President and trader of interest rate derivatives. He later joined Credit Suisse First Boston, New York, in the same capacity as a derivatives trader and market maker in the banks Funding Department. In 2000, Greg transitioned to FXDD where he was one of the founding employees of FX DirectDealer (later FXDD). While at FXDD, he helped manage the currency risk, and later become the Chief Currency Analyst. Greg has educated and spoken around the globe to thousands of retail traders. He has written for various publications including Equities magazine. His thoughts on the forex market have appeared in the Wall Street Journal, Bloomberg, and Thomson Reuters.
Greg Michalowski, Founder and President of GregMikeFX.com, a foreign exchange consulting company, and author of Attacking Currency Trends (WIley Publishing) has 28 years experience as a trader and financial analyst. His career began at Citibank New York and later at Citibank London where he was a Vice President and trader of interest rate derivatives. He later joined Credit Suisse First Boston, New York, in the same capacity as a derivatives trader and market maker in the banks Funding Department. In 2000, Greg transitioned to FXDD where he was one of the founding employees of FX DirectDealer (later FXDD). While at FXDD, he helped manage the currency risk, and later become the Chief Currency Analyst. Greg has educated and spoken around the globe to thousands of retail traders. He has written for various publications including Equities magazine. His thoughts on the forex market have appeared in the Wall Street Journal, Bloomberg, and Thomson Reuters.

In June the ECB announced a number of stimulative measures including lowering rates and announcing a Targeted Longer Term Refinancing Operation or TLTRO that would take effect starting on September 18th. The TLTRO is a way for the ECB to flood banks with liquidity at below market term interest rates for a period going out to as long as 4 years.  The underlying goal of the program is to:

  1. Provide banks with cheap fixed rate funds for an extended period. This should – over time – increase the Euro banks capital from  the simple accruing of carry profits from lending or investing at higher market rates and borrowing at below market rates from the ECB
  2. Increase lending to businesses. The ECB is looking to encourage banks to make funds available to Euro area businesses.  If done, the banks would be eligible for more cheap funding from the ECB.  The hope is that the loans to businesses, lead to new jobs, earnings, spending and perhaps even a little inflation.

Why the aggressive stimulus?

Inflation in the EU is dangerously close to moving down more toward 0.0%. The CPI Flash estimate announced on July 31st moved to 0.4% YoY, down from 1.6% a year ago. The official CPI will be released next week with expectations for a 0.4% YoY gain.  That is not good news when the ECB is targeting 2% inflation 

On Tuesday, Italy announced that GDP fell by -0.2% in the 2Q. This comes on the back of a -0.1% in the 1Q which once again – by definition – puts the Italian economy back into a recession (two back to back quarters of negative growth). EU GDP will be released next week, and is expected to show a 0.2% QoQ gain. It will be the 5th consecutive quarter of growth but the YoY is only +0.9%.  

In short, the economy is not moving fast enough and inflation is starting to getting closer to 0.0% and further away from the targeted 2.0%.

Interest Rate Decision and Press Conference on Thursday but what can the ECB do?

The problem for the ECB and President of the ECB Mario Draghi as they/he prepares to release their next interest rate statement, and give the scheduled press conference on Thursday, is that some of the bullets have been shot and some bullets are in the chamber and waiting to be shot.  That is, rates are about as low as they can go. So there is little else they can do there. The TLTRO has the potential to be a huge stimulus, but It is August and it won't be initiated until September 18th. The ECB can not realistically add any more stimulus without knowing at least, how much funds will be apportioned to banks in September when they issue their tender for TLTRO funds.  

So there seems to be little the ECB can possibly do on Thursday…except talk.

What might talking accomplish?  

One thing that Draghi and the ECB can do is attempt to talk down the the value of the the EUR.  By doing so, it would give a boost to the export economy of the EU, encourage overseas tourism and perhaps lead to some import inflation in the process. All of which would provide some needed medicine for the EU woes.

Now it is true the EUR is down against all the major currencies in 2014. For example, against the JPY the EUR is down 5.57%, against the GBP it is down 4.39% and against the USD it is down 2.63%.  

However, looking back to the 2012, the EURJPY is up from 94.00 to 136.64. That is a 45% increase.  Against the USD, the 2012 low for the EURUSD was 1.2041. It is currently at 1.33816. That is still 11.11% higher than the low point.  Against the GBP, the EURGBP has come down significantly as the pound sterling appreciated on the back of a stronger UK economy, but the EUR is still higher than 2012 levels by 2.4%.  

In short, for an economy that has some of the lowest growth and lowest inflation, playing up your currency does not seem the logical thing to do.  It is ok. Don't be so scared.

So although Draghi and ECB have their hands tied with little to do from a stimulus perspective, they do have the option for some good old fashion "our currency is still too high and is impacting growth and inflation in a negative way".  I don't think it will hurt and has the potential to provide in a time when there is little else that they can do.   

Do they have the courage to just talk it out?  I don't see why not but unfortunately I don't have a vote or a voice (except here of course). 

Good fortune with your trading. 

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If you are interested in learning more about forex and forex trading visit my website at www.gregmikefx.com