Throughout this week news headlines were dominated by one thing: Thursday’s press conference of the European Central Bank. Despite losses for the euro over the past few weeks, largely due to the political tensions between Spain and Catalonia, the single currency managed to recover some of its losses this week, on the expectation that the ECB would finally announce a plan to phase out of its ambitious stimulus program. Did that happen? It seems that the answer is somewhat complicated.
Let us take a step a few years back first. Amid the fallout of the economic crisis of 2008 the global recession reached Europe and we saw massive economic slowdowns even in the most developed countries in the world. This prompted a new dovish trend among central banks: buying government bonds on a massive scale in order to promote growth and inflation. We saw this happen in the United States, in Japan, and even in Europe.
This is why the European Central Bank has been buying 60 billion euro worth of bonds per month over the past few years. Their efforts have shown results – economic data from all over the eurozone comes in consistently positive, European countries are enjoying economic growth of 2-3%, and inflation has increased, compared to 2008. This positive effect has prompted investors to hope for an end to the stimulus measures, which would allow the euro to start increasing in value against major currencies.
Yesterday’s press conference of the ECB, however, brought mixed results. The central bank finally showed a willingness to move away from stimulus by announced a reduction of the package in half – from 60 down to 30 billion euro per month. That would have been good news for investors and for the euro, had it not been for one addition – the ECB plans to continue with the measures well into 2018, possibly until September. The stimulus package is still needed, according to the ECB, because the healthy inflation rate of 2.0% has not been achieved yet (it is at 1.5% currently).
The markets were hoping for something more short-term, rather than the nine months of bond redemption planned for 2018. As a result, the euro dropped dramatically overnight, falling to trade around 1.1626 today. While investors were hoping to awake to a stronger euro, it seems that the ECB prefers it this way: by preventing the euro from appreciating, the ECB is ensuring exports from the EU are not going to suffer.
So, what’s in store for the euro? The ECB has shown an ability to act flexibly. They would keep a close eye on data from the EU, particularly to wage growth and inflation. It is possible that they would revise their expectations at their next meeting in December. Most importantly, investors need to understand that the ECB is trying to move very slowly, as sudden changes in the financial markets could have a harmful effect and undo all the good the stimulus program has achieved so far. In general terms, this means we are not likely to see a much stronger euro within the next year – unless there are external reasons, such as problems with the American dollar, for example.
