ECB forward guidance not strong enough

Euro drifts lower after European Central Bank president Draghi said the Bank “strongly emphasizes” its “accommodative stance on monetary policy”. Last month, Draghi mentioned forward guidance without the added emphasis.

Yet, the overall reality remains the same; as last month, Draghi reiterated there was no discussion of negative deposit rates or a reduction in the refinancing rate, and gave no hints on the euro being too high as was the case in February of last year.

The more effective way for a central bank to strengthen its forward guidance (to weaken bond yields and cap its currency) is to not simply restate it, but to add reference targets such as the unemployment threshold in the US and the UK, and even going further, with adding reference to inflation.

As we have argued here, central bank forward guidance is more effective when it succeeds at keeping currencies pressured and yields capped. The fact that the euro outperformed the USD and GBP last year proves this point.

The ECB’s forward guidance has been limited to maintaining a downward bias on interest rates and keeping the door open for negative refinancing rate. But reiterating the forward guidance without credible hints at additional easing no longer does the trick. And the euro is where the ECB wants it.

The BoE offered a bit more in forward guidance than the ECB by setting an unemployment threshold of 7.0% with a preferred inflation threshold near 2.0%. the fact that unemployment has fallen faster than the slowdown in inflation is keeping GBP underpinned and UK yields above all G7.

The Fed offers the clearest of forward guidance by further delaying rate hike prospects after stating that no rate was viable increase as long as unemployment is “considerably below 6.5%” and if inflation were “to remain below our 2% objective”. An effectively stated dual guidance goes a long way in keeping bond vigilantes in check.

Last but not least, Draghi today downplayed speculation of a near-term rate cut, by associating the latest slowdown in December Eurozone inflation to temporary seasonal factors in Germany. The ECB is neither ready to cut rates again, nor it will signal the pulling of the trigger when non-inflation macro fundamentals are stabilizing and periphery bond yields are plunging. We do not rule out the EURUSD’s short-term pullback towards $1.33 on diverging US-Eurozone growth paths, before building on further gains towards 1.45 late in Q3 as “tightening” fatigue in the US converges with pro-Euro dynamics in terms of balance sheet liquidity and current account balances.

StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. CFD and Forex Trading are leveraged products and your capital is at risk. They may not be suitable for everyone. Please ensure you fully understand the risks involved by reading our full risk warning.

City Index is a trading name of StoneX Financial Ltd. Head and Registered Office: 1st Floor, Moor House, 120 London Wall, London, EC2Y 5ET. StoneX Financial Ltd is a company registered in England and Wales, number: 05616586. Authorised and regulated by the Financial Conduct Authority. FCA Register Number: 446717.

City Index is a trademark of StoneX Financial Ltd.

The information on this website is not targeted at the general public of any particular country. It is not intended for distribution to residents in any country where such distribution or use would contravene any local law or regulatory requirement.