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The Key Takeaway from the ECB Decision

The Key Takeaway from the ECB Decision

Kathy Lien, Technical Strategist

Optimism from ECB President Mario Draghi and the Bank’s expectations for economic stabilization lessen the chances for additional stimulus, and the euro is rallying ahead of Friday’s US non-farm payrolls data.

Forex traders drove the euro (EUR) higher on the back of today’s European Central Bank (ECB) monetary policy decision. While the ECB left interest rates unchanged at 0.50%, slightly more optimism from ECB President Mario Draghi was enough to send the currency to a nearly four-week high.

Draghi spent a bit more time this month talking about the improvements in Eurozone economic data and the expectations for stabilization and a gradual recovery in 2013. However, he did not rule out the possibility of negative rates and instead made it clear that this option was discussed along with asset-backed securities (ABS), longer-term repayment obligations (LTROs), collateral, and credit claims.

Therefore, the main takeaway from the ECB today is that all options are still open, but the Bank’s expectations for stabilization reduce the chance for additional stimulus.

We have long felt that even though policymakers introduced the idea of negative deposit rates, the bar is high, and with ECB officials divided on its efficacy, the Eurozone economy needed to deteriorate significantly in order for the central bank to resort to this option.

Draghi basically ruled out buying asset-backed securities by saying that it would take a prolonged period to get a plan into action, and more importantly, that the market for ABS has been dead for many years.

The central bank also did not address other types of forward guidance, and together, these all confirm that there is very little urgency right now to follow up last month's rate cut with additional easing.

Part of the reason is because even though the ECB cut its growth and inflation forecasts this year, it raised the GDP forecast for 2014, reflecting expectations for stronger growth next year.

The Revised ECB Growth Expectations

The ECB now expects the Eurozone economy to contract by -0.6% in 2013 versus a prior mid-range forecast of -0.4%. GDP growth for 2014 is now expected to reach 1.1%, up from a prior forecast of 1.0%.

The risks to the outlook remain to the downside because of structural reforms, but exports and accommodative monetary policy are expected to be the drivers of recovery. Inflation risks are broadly balanced, but CPI is now expected to come in at 1.4% this year versus the initial 1.6% because of the volatility in oil prices.

While the ECB is keeping monetary policy easy and all options are open, the brighter outlook means the Bank is not poised to pull the trigger on additional stimulus anytime soon, which was enough for FX traders to buy the euro.

US NFP Data Due Friday

However, the sustainability of the euro gains now hinge upon Friday's US non-farm payrolls (NFP) report. If job growth slowed last month, profit taking on long dollar positions could drive EURUSD above 1.32.

Based on yesterday's non-manufacturing ISM and ADP reports, the risk is skewed to the downside for NFPs, but jobless claims have been low, thus providing an ounce of hope for the market. This morning's releases also helped, as job cuts fell 41.2% in the month May, according to Challenger Grey & Christmas, and jobless claims fell to 346K from 357K.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.