The common currency posted one of its best one-day rally against the U.S. dollar in nearly a year last week. Alongside the gains in the currency, bond prices fell sharply. The reaction came as the European Central Bank president, Mario Draghi signaled that the central bank could begin to wind down its stimulus program.
The hawkish comments from the ECB president come just a few days after the Bundesbank president, Jens Weidmann who also serves on the ECB’s governing council signaled his preference for tighter monetary policy.
The surprisingly hawkish remarks from the ECB president Draghi, on the other hand, came just a day after he said that there were risks to prematurely tightening monetary policy. At the time of making the comments, the Eurozone flash inflation estimates were yet to be released.
Any potential policy moves from the ECB towards cutting back the bond purchases will be similar to that of the Fed’s tapering. The intention to tighten policy was first executed by winding down the QE before interest rates began to rise.
The ECB’s QE was at 80 billion, before being cut to 60 billion in March this year. The next expected cut to QE is likely around September, which will bring the QE purchases to 40 billion. The ECB’s bond purchases were expected to run until December 2017 with the potential to extend beyond December if need be.
Draghi at the Economic Policy Conference
Draghi’s comments last Tuesday came at the economic policy conference that was hosted in Portugal. Despite the main headline being hawkish, Draghi’s speech was full of caution. However, for the market participants, this was the comment that they were waiting for since the ECB’s last meeting.
Speaking at the conference, Draghi said, "All the signs now point to a strengthening and broadening recovery in the euro area."
Investors bid the euro higher which rallied as much as 1.4% on the day. It was also the biggest jump seen since June 2016, and the EURUSD closed the day (Tuesday) at $1.1340, after comfortably breaking past the $1.1300 hurdle.
EURUSD reaction to Draghi’s comments
There were also rumors from “unknown sources at the ECB’ that the market was misinterpreting Draghi’s comments. The euro fell but quickly recovered off the $1.130 technical support.
The ECB has been buying eurozone bonds to the tune of 2.3 billion euro. Bond yields rose with prices falling. It also included bonds from Germany and Italy as well.
With the political risks now becoming tailwinds, the path ahead for the ECB is likely to be smooth, provided the current pace of economic recovery is maintained, and inflation shows signs of a pickup.
The ECB’s next policy meeting is due in mid-July where the central bank could give out further details on how it intends to taper its bond purchases.
Consumer climate in Germany and France expected to drive growth in the Eurozone
On Thursday, the Gfk’s consumer climate data showed a pickup with the upswing in the mood among consumers in Germany. For July, the Gfk’s forward looking indicator projected a 0.2 point increase to 10.6, up from 10.4 the month before. The research institute said that its forecast for real private consumer spending would rise 1.5% in 2017.
Gfk German Consumer Climate (July 2017)
Besides the German consumer climate, French consumer mood was also seen rising to the highest levels in nearly 10 years, suggesting that the economic recovery is slowly becoming firmly entrenched.
Eurozone flash inflation estimates
On Friday, the Eurozone’s flash inflation estimates were released by the eurozone. The preliminary data on inflation for June showed that headline consumer prices increased 1.3%, while core consumer prices rose 1.1%.
This was higher than the previous month’s inflation report which showed headline CPI rising 1.4% and 0.9% a month before.
With the flash inflation estimates more or less validating that inflationary pressures were rising, the ECB could very well be on track with its tightening policy.
