Draghi to Keep Quiet on Euro

<p>Less than seven months after ECB president Draghi vowed to “preserve” the euro and make it “irreversible”, he is highly unlikely to hint at thwarting […]</p>

Less than seven months after ECB president Draghi vowed to “preserve” the euro and make it “irreversible”, he is highly unlikely to hint at thwarting its appreciation any time soon.

Draghi is fully aware that any talking down of the euro, whose economic challenges and political uncertainty are far from over, could send renewed downward pressure on the currency and its peripheral sovereign bond markets. 

How Trichet did it?

Back in the days when EUR/USD hovered above $1.4500, there were three typical ways in which former ECB president used to talk down rapid gains in the currency:

i) stating he was watching markets with “strong vigilance”;
ii)  was watching markets “monitor very closely” and;
iii) expressing commitment to US officials’ stance on a “strong dollar policy”.

Draghi is unlikely to pursue the latter option because US officials have not made such claims about a strong US dollar in nearly two years. More importantly, we don’t expect Draghi to make any references to “watching” the markets with “vigilance” because these consist of a threat to intervene, which would be counterproductive considering the currency was on the verge of collapse six months ago.

Markets to Ignore the French

French presidents are notorious in their protests against excessive currency appreciation. Giscard D’Estaing’s franc devaluations in the late 1970s, Mitterand in the 1980s, Chirac in 2003-04, Sarkozy in autumn 2009 and now Hollande– who said yesterday “we have to act at the international level to assert our interests”. Markets quickly disregarded Hollande’s remarks after German officials rebuffed Paris, saying “exchange rate policy isn’t an appropriate instrument to boost competitiveness” and that recent appreciation was making up for “massive” depreciation last year.

This is not 2005

It it is important to remember that this is not January 2005 when Trichet’s warning of “violent moves” in FX dragged down euro at the time. In 2005, there were two other reasons for the ensuing euro decline that year:

1) Fed began tightening in 2004 and ECB didn’t begin to tighten until Dec 2005;

2) US Homeland Investment Act drove US companies to repatriate funds to take advantage of the Act’s temporary tax cut aimed at drawing capital to the US. Over $270 bn was repatriated by US companies in 2005. When the ECB began tightening in Dec 2005 and the Fed paused in June 2006, the US dollar’s damage ensued.

In the event that the euro exceeds the $1.40 level at a pace of more than three cents per week (or 2% per week) for 3-4 weeks, then the ECB will likely resort to jawboning, but not monetary policy. The Frankfurt-based institution may have run against the Bundesbank’s “hard money” ideology when announcing the OMT in September, but it will certainly not resort to cutting rates to weaken the currency when it refrained from doing so in stabilising the Eurozone.

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