Euro Tumbles After ECB Commits to Staying the Course

Market Trends - 29/03/2017

Although much of financial markets’ attention has been focused exclusively on the start of Brexit negotiations and a new Scottish independence referendum, the Euro has recently been under pressure by comments from ECB sources regarding the pace of policy adjustments.  Per Reuters, officials from the European Central Bank are eager to dispel interpretations that the institution will embark on policy tightening before the Governing Council meets in June.

Following the last decision a few weeks earlier in March, market participants were largely operating under the presumption that the absence of language outlining the tail risks facing the Euro Area was a hawkish signal for the policy outlook.  As a result, bond yields started to rise, bringing the Euro higher as well as investors prepared for an earlier end to accommodation than previously anticipated.  However, the ECB is now roundly rejecting this “overinterpretation,” sinking the Euro as a result.

While it is easy to point to improving conditions across the Euro Area in terms of inflation, employment, and GDP growth, there are still enough weak spots to dissuade the Governing Council from acting quicker to shelve stimulus.  For one, the impact of the energy price rebound is gradually fading, likely reducing some of the upside pressure on consumer prices over the medium-term.

Furthermore, while monetary conditions remain exceedingly supportive of growth throughout the monetary union, there are several potential events that could derail the current guidance, many of which are political in nature and thus, difficult to price.  Upcoming elections in France along with growing anti-EU rhetoric could create enough uncertainty for the ECB to shelve any plans to gradually reduce or even end asset purchases.  With officials pushing the idea that asset purchases will have to end before rates begin to rise, markets have quickly turned from bullish to bearish, sending the EURUSD pair tumbling as monetary tightening optimism rapidly fades.

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