European Central Bank President Marion Draghi will walk into today’s press conference with mixed feelings. On the one hand he can take one look at the Eurozone data on inflation and PMI surveys with a degree of satisfaction in the knowledge that the bank’s policy of QE seems to be making a difference. On the other hand this improvement is resulting in a euro rally. In the meeting of the second half of 2014, Draghi became rather adroit at managing to jawbone the euro lower without really doing a great deal. He may feel the need to do so again today.
Since QE was confirmed in its January meeting, the ECB will have been watching the economic data. The forward-looking Purchasing Managers Indices have been steadily improving. These are forward-looking surveys, that effectively measure how businesses will be looking to expand (measures above 50) or contract (below 50). The manufacturing survey has been picking up steadily in the past few months, especially since the announcement of QE.
The ECB would have also noted that inflation has picked up in the past few months. Moving from -0.6% (or deflation) in the January data, the Eurozone has quickly picked up to move back into inflation of +0.3%. It is not just the fact that the Eurozone is no longer in deflation, but also the path of the improvement in recent months. Not only that, the flash CPI data released yesterday was ahead of the market forecast of +0.2%. The Eurozone inflation is suddenly running higher than consensus forecasts. The absolute transmission of QE into inflation picking up so soon is debatable, however the announcement of QE was well touted in late 2014 (even if the actual purchases did not begin until March).
So that is all good so far for the Eurozone, however this is also having a side effect. The euro is strengthening as these economic data points have picked up and the prospects for the Eurozone have improved. The up tick in Eurozone indicators has come at a time where the US is going through a decidedly mixed patch of data. This is one of the reasons why EUR/USD is no longer an outright sell anymore. Also, question marks remain over exactly when the Fed will move to hike rate, whilst a clutch of dovish FOMC member statements in recent days (from Rosengren, Fischer and Brainard) have posed more questions than given answers. This is all adding to a mix of an uncertain outlook for EUR/USD.
One of the reasons behind the turnaround in economic prospects of the Eurozone has come from the sharp decline in the value of the euro in recent months. However, in the wake of the surprise beat on inflation yesterday, the euro pushed strongly higher, by over 200 pips on the day. This would have been a bitter-sweet day for Draghi. A weaker euro has been a positive for the region’s competitiveness and the higher the euro is against the dollar, the worse these trade terms become.
So will Draghi take the opportunity to talk the euro lower again? Bund yields spiked sharply higher yesterday and if Draghi can put emphasis on this supposed frontloading of QE purchases in June ahead of the summer lull in the markets then this may act as a drag on Bund yields once more. Also, therefore with the positive correlation between Bund yields and the euro then this could also help to drag the euro lower too.
However, another driver of the euro gains has been rumours of progress in the Greek negotiations. Draghi could have to concede the euro going higher in the near term, as progress in the talks between Greece and its creditors would suggest there is a reduced likelihood of a Greek default on its debt. There is now a proposal on the table and the Greeks have an opportunity to finally come to an agreement which would ensure the show chugs on down the road. As ever though, with the Syriza led Greek government, nothing seems to be straightforward and a deal is by no means a given, as the IMF repayment deadline on Friday moves veer closer.
Add in the fact that we have Non-farm Payrolls this week too. One thing is for sure, the volatility on Euro/Dollar is unlikely to be over quite yet. Strap yourselves in.