ECB disinflation brushoff supports euro

Another ECB press conference sends the euro higher as European Central Bank president Draghi did not share markets’ concerns with prolonged declines in inflation. Not only Draghi he touted the benefits of low inflation on real incomes, but also explained falling prices to be largely a result of weak energy prices and concentrated in bailout countries. The conference appeared to suggest the ECB is in no hurry to use up its eroding interest rate armory to tackle disinflationary without using loan- enhancing measures such as conditional LTRO.

Unlike in the December meeting, the current ECB decision follows a broadly positive string of German and pan-Eurozone data, namely the highest manufacturing PMI in 3 years for Germany and Eurozone at 56.5 and 54.0 respectively (compared to the ISM’s 51.3 in the US), the highest German IFO figures in 3 years and highest German ZEW survey in 10 years.

The ECB’s forward guidance has been limited to maintaining a downward bias on interest rates and keeping the door open for negative refinancing rate. But reiterating the forward guidance without credible hints at additional easing no longer does the trick. And the euro is where the ECB wants it.

LTRO with a twist

Eurozone dynamics continue to reveal the rare combination of broad-based improvement in business surveys, falling sovereign bond yields and lingering risk of disinflation. Such a contrast between stable market metrics/recovering macro dynamics and slowing prices is likely to eventually put the onus back on the LTRO option with a twist (requiring banks to spend proceeds in the economy & not just for buying bonds for carry trade purposes), particularly due to falling liquidity at the ECB. But note that as long as markets are not undergoing the tightness of summer 2012, then an LTRO announcement would be EUR- positive – as was seen after the announcement of late 2012.

Euro at risk from Yellen’s testimony

Euro’s upward momentum could well be extended towards 1.3650s on any downside surprise from Friday’s jobs figures, but Tuesday may trigger fresh losses if Fed Chairwoman Yellen’s Congressional testimony signals the likelihood of further tapering ahead despite the recent developments in emerging markets and gloomy data from US manufacturing. Next support emerges at 1.3280.