Author: Gordon Platt

The euro fell from a multiyear high against the dollar in early May, after European Central Bank president Mario Draghi said the bank’s governing council is ready to act in June, if necessary, to ease monetary policy to counter low inflation.

 With an ECB rate cut in the offing, and strengthening US economic data, it is likely that the euro will continue to grind lower, says Alistair Cotton, senior analyst at Currencies Direct, a London foreign exchange broker and international payments provider. “The pace of the European recovery is open to uncertainty, with a long slog probable,” says Cotton.

The ECB needs to pump liquidity into the banking system to support bank lending, but negative interest rates on deposits at the central bank are more likely than quantitative easing, at least at first, Cotton adds.  The ECB, he notes, should begin developing a mechanism for asset purchases at a later date.

Although the governing council decided to keep policy on hold at its May meeting, the group was comfortable about acting in June, Draghi said, because they shared the view that inflation was too low. The ECB staff is expected to revise its inflation forecasts even lower ahead of the June meeting.


Draghi also commented on the strength of the euro, which is making it more difficult to reach the bank’s inflation target. Although the ECB has no exchange-rate target, the governing council, Draghi said, had discussed euro intervention.

“Although he has said many times that the euro is not part of the policy mandate, by putting the [exchange] rate in the context of price stability, the governing council has [given itself] more flexibility to act,” notes Christopher Vecchio, currency analyst at DailyFX, the research website of FXCM.

“How long can Draghi tease the market without gratifying it?” queries Marc Chandler, global head of currency strategy at Brown Brothers Harriman. “Draghi, of course, repeated that the central bank is unanimous in supporting unconventional policies if necessary. The ECB has been saying for more than a year that it is prepared for a negative deposit rate.”


All of the talk without action is hurting the credibility of the ECB, Chandler says. “Reading between the lines, it appears that even if Draghi himself wanted to ease policy, he is institutionally constrained by the need for consensus,” Chandler says. “Several of the creditor countries, led by Germany, are more worried about interest rates being too low for too long than they are about the low inflation.”

Analysts at Barclays Research said they expect the ECB to cut official rates at its June meeting and/or to launch a targeted liquidity injection to support bank lending. “We do not think that the ECB is ready to launch a large-scale asset purchase program at this stage,” they add.

Meanwhile, analysts continue to debate why the dollar has remained weak despite the improving US economic outlook. “Perhaps the ongoing downward pressure on the dollar is related to the ongoing liquidity creation in the US and the lack of liquidity absorption by the US equity market so far in 2014,” says Jens Nordvig, global head of FX strategy at Nomura. “Perhaps we need to get closer to the actual [Federal Reserve] tightening before the dollar can actually take off.”

Joe Manimbo, senior market analyst at Western Union Business Solutions, adds: “The dollar has been undermined by the inability of positive data to move the needle forward on the prospects of a Fed rate hike next year. The Fed has made it clear that it is still premature to talk about higher US rates.”