The minutes released following the ECB’s controversial decision in December to ease policy less than the market had expected showed broad support for the action among the governing council. While there were indications that some members wanted to do more, likely including President Draghi, the minutes showed little sign of major dissent.
Markets, however, displayed their displeasure about the decision by bidding up the value of the euro almost 3% in the day following the announcement. Fixed income markets also reacted negatively with bund yields increasing 20bps. Overall, financial market historians will remember December 2015 as being rather odd. In a month where the Fed tightened policy and the ECB eased, the euro gained ground versus the USD – certainly not what Economics 101 textbooks teach.
Given that much of 2016’s appreciation in the euro should be reversed as risk appetites rebound and short positions are reestablished, the pressure on the ECB to act should decline. That said, President Draghi stated that the path for inflation was sharply lower than forecast and downside risks have increased since the beginning of the year. Indeed, inflation actually ended the year at lower levels than were expected. And with energy prices continuing their descent, inflation expectations have deteriorated further.
As a result of Draghi’s comments, market chatter about additional stimulus has increased. Even though the euro area has been showing signs of life recently with core infl ation trending higher, the ECB could easily justify a decision to increase the pace of monthly purchases at its March meeting. The seed President Draghi has planted will encourage further euro weakness before more favourable economic fundamentals begin supporting the currency later in the year. Indeed, taking a step back from the current volatility in markets, we expect the euro area to support global growth this year by growing its economy by just under two percent in 2016.
CIBC targets EUR/USD at 1.07 by end of Q1 and at 1.14 by end of the year.
This article originally appeared at eFXnews.