UPDATE: Euro Plummets After ECB Refrains from Bond Buying Program

THE TAKEAWAY: EUR ECB Press Conference > No major bond buying program > EURUSD BEARISH

Although the Euro traded higher following the European Central Bank Rate Decision, in which the main overnight refinancing rate was held at 0.75%, the common currency has plummeted across the board following the European Central Bank’s decision to refrain from a bond buying program.

EURUSD 1-minute Chart: August 2, 2012

Charts Created using Marketscope – Prepared by Christopher Vecchio

The EURUSD has taken it on the proverbial chin, falling from a session and weekly high of 1.2405 to as low as 1.2173 within the hours following the non-news that the European Central Bank did not have a bond buying program in place, as expected following last week’s ultra-dovish commentary from President Mario Draghi. The EURUSD has since rebounded to 1.2186, at the time this report was written, but we view this pause in the decline as a consolidation, rather than a sign of a near-term bottom.

Presented below without commentary are the key highlights from President Draghi’s press conference:

On inflation:

• As we said a month ago, inflation should decline further in the course of 2012 and be below 2% again in 2013.
• Consistent with this picture, the underlying pace of monetary expansion remains subdued.
• Inflation expectations for the euro area economy continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term.
• On the basis of current futures prices for oil, inflation rates should decline further in the course of 2012 and be below 2% again in 2013.
• Over the policyrelevant horizon, in an environment of modest growth in the euro area and wellanchored long-term inflation expectations, underlying price pressures should remain moderate.

On economic growth:

• Economic growth in the euro area remains weak, with the ongoing tensions in financial markets and heightened uncertainty weighing on confidence and sentiment.
• A further intensification of financial market tensions has the potential to affect the balance of risks for both growth and inflation on the downside.
• Economic indicators point to weak economic activity in the second quarter of 2012 and at the beginning of the third quarter, in an environment of heightened uncertainty.
• Looking beyond the short term, we expect the euro area economy to recover only very gradually, with growth momentum being further dampened by a number of factors.
• In particular, tensions in some euro area sovereign debt markets and their impact on financing conditions, the process of balance sheet adjustment in the financial and non-financial sectors and high unemployment are expected to weigh on the underlying growth momentum, which is also affected by the ongoing global slowdown.
• The risks surrounding the economic outlook for the euro area continue to be on the downside. They relate, in particular, to the tensions in several euro area financial markets and their potential spillover to the euro area real economy.
• Downside risks also relate to possible renewed increases in energy prices over the medium term.

On monetary conditions:

• The underlying pace of monetary expansion remained subdued.
• The soundness of banks’ balance sheets will be a key factor in facilitating both an appropriate provision of credit to the economy and the normalization of all funding channels.

On the crisis:

• While significant progress has been achieved with fiscal consolidation over recent years, further decisive and urgent steps need to be taken to improve competitiveness.
• From 2009 to 2011, euro area countries, on average, reduced the deficit-to-GDP ratio by 2.3 percentage points, and the primary deficit improved by about 2½ percentage points. Fiscal adjustment in the euro area is continuing in 2012, and it is indeed crucial that efforts are maintained to restore sound fiscal positions.
• At the same time, structural reforms are as essential as fiscal consolidation efforts and the measures to repair the financial sector. Some progress has also been made in this area.
• Product market reforms to foster competitiveness and the creation of efficient and flexible labour markets are preconditions for the unwinding of existing imbalances and the achievement of robust, sustainable growth.
• It is now crucial that Member States implement their country-specific recommendations with determination.

On commentary from last week, suggesting the ECB would unveil a major bond buying program:

• The European Central Bank “may” buy bonds.
• President Draghi says he didn’t signal breach of mandate in London (in reference to comments last week).
• Says it’s within ECB’s mandate to preserve the Euro.

--- Written by Christopher Vecchio, Currency Analyst

THE TAKEAWAY: EUR European Central Bank Rate Decision > Main refinancing rate on hold at 0.75% > EURUSD BULLISH

The European Central Bank kept its main refinancing rate on hold at 0.75%, as expected, amid a deepening European sovereign debt crisis. Whereas European Central Bank President Mario Draghi promised measures last week to help stem the crisis, little has materialized thus far, as market participants away the much anticipated press conference at 08:30 EDT /12:30 GMT today.

Accordingly, because there was no rate cut, it appears that investors are covering their Euro shorts as well as repositioning themselves for a major bond buying program to be announced during the European Central Bank’s press conference. Speculation has arisen that if the European Central Bank kept rates on hold, it would be a sign that further nonstandard measures were on the verge of being announced today. Thus far, we are in wait-and-see mode.

EURUSD 1-minute Chart: August 2, 2012

Charts Created using Marketscope – Prepared by Christopher Vecchio

Still, in response to the rate decision, in which the Credit Suisse Overnight Index Swaps were pricing in an 82% chance of a 25-basis point rate cut today (from 0.75% to 0.50%), the Euro has climbed across the board. The EURUSD jumped from 1.2262 ahead of the release to as high as 1.2347 soon after, and was trading at 1.2339, at the time this report was written. Similar price action was observed in the EURJPY, which jumped from 95.90 to as high as 96.65, before pulling back to 96.52.

To follow developments from the European Central Bank’s press conference, visit DailyFX’s FX squawk box, the Real Time Forex News Feed.

--- Written by Christopher Vecchio, Currency Analyst

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