EUR/USD: Dollar's loss is euro's gain - Rabobank

Jane Foley, Senior FX Strategist at Rabobank explains that the ECB is concerned about the EUR’s upward momentum, but the message from ECB President Draghi was a little half-hearted and the USD is still in the dog-house.

Key Quotes

“As a consequence of the headlines that spilled from the ECB’s latest press conference, it is impossible not to have noticed that the ECB Governing Council are concerned about the recent gains in the value of the EUR.  ECB President Draghi made clear that while in the last meeting only a few members of the Council had concerns about the exchange rate, this time most members reiterated these worries.  He also specified that as a result of the appreciation of the EUR, that the central bank’s estimates of medium-term inflation had been revised lower.  Not only this but Draghi’s post council meeting statement was arranged so that a reminder that the ECB stands ready to increase is policy accommodation was reiterated before he moved on to outlining his upbeat assessment of the economy and the upward revision to Eurozone GDP growth.  That said, the Governing Council’s concerns about EUR strength were delivered with a lack of conviction.”

“The markets concentrated instead on the hints that most details regarding a tapering of its QE are likely to be delivered in October.  Consequently, EUR/USD proved to be impervious to Draghi’s comments regarding the exchange rate and it moved up and beyond the 1.20 level as he delivered his post Council Meeting comments.  The robustness of the EUR’s rally has led up to revise up our EUR/USD forecasts.  We expect a move to the 1.25 area by the middle of next year, this compares with a previous target of 1.20.” 

“The attraction of the EUR is clearly not solely driven by the simple carry trade.  The 10 month low reached in US 10yr t-notes this week is another negative factor for the USD.  That said, interest rate differentials have not been a particularly useful predictor for EUR/USD in recent months given the influence of political factors.  By any measure   ECB interest rates are very low and, even though the market remains convinced that the ECB will taper its huge QE programme next year, policy settings remain accommodative and rates are set to remain on hold ‘for an extended period’.”

“In view of the low level of core inflation in the region which “has yet to show a convincing upward trend” and the tightening of monetary conditions implied by the exchange rate, the ECB is likely to be mindful that a winding down of QE may choke the expected rise in price pressures.  Consequently, we expect the ECB to underpin the prominence of its soft interest rate policy whilst it gradually reduces QE next year.  Yesterday’s remark from Draghi that the Council had not discussed ‘sequencing’ suggests there was little attention given to the issue of rate rises at this month’s policy meeting.”