The market was rocked last week as the ECB delivered a blow with a double-edged sword at its June monetary policy meeting. The central bank announced that it would wind down its massive quantitative easing program by the end of 2018 though bulls were left disappointed as Draghi added the caveat that rates will be kept on hold “at least through the summer of 2019”.
The market has interpreted the move as broadly negative for the Euro with a large disruption to the market pricing for ECB rate hikes. Implied probability of a 10% rate hike in June 2019 has now fallen from 63% to 27%. While the drop off has been severe, policy expectations will of course track incoming data which present risks in both directions.
EUR Sensitivity To Data
The ECB’s strict pledge to keep rates low until at least the summer of 2019 means that the Euro will likely be less sensitive to incoming data in the short term. Additionally, its will likely take some significant upside data surprises in the Eurozone for the ECB to consider hiking earlier than forecast. Consequently, the EUR is exposed to a negative skew in terms of expectations for ECB action which should keep price weighed.
Growth Revised Lower
While the ECB’s message on rates was clear cut, the message on growth was slightly less clear. On the one hand, Draghi highlighted the strength of the Eurozone recovery despite recent weakness though also highlighted the recent data softness and the new downside risks linked to volatility in financial markets. The message on growth also included downward revisions to the ECB staff projections for 2018 (2.4% to 2.1%) while projections for 2019 and 2020 remained unchanged at 1.9% and 1.7% respectively.
Inflation Revised Higher
Referring to inflation, Draghi said that “measures of underlying inflation remain generally muted”, the staff projections similarly didn’t point to any immediate inflationary pressures. Notably, the forecasts for 2018 and 2019 were revised higher to 1.7% over both years, reflecting higher oil prices, though 2020 inflation remained unchanged at 1.7%.
Wage Growth Up
Following the ECB’s meeting we have seen some solid eurozone data with Q1 2018 wage growth up to 1.8% from 1.6% in the final quarter of 2017. The outlook for the rest of the year also looks solid, as the general improvement in the labour market has seen the re-emergence of labour shortages, with the unemployment rate continuing to fall.
Trade Data Disappoints
Trade data however has not been as pleasing. Seasonally adjusted trade data for April was mixed with imports growing at a quicker rate than exports at 1.4% and 0.4% respectively. Due to the fact that this data is nominal, higher oil prices will likely have boosted the import data which won’t be reflected in the GDP figures. Furthermore, as exports were already weaker in recent months, the impact of steel and aluminium tariffs from the US is likely to be significant.
After rallying off the 1.1540 – 1.1460 base, EURUSD has since fallen back down to retest the structural support zone. While this area holds, there is still the potential for price to rally higher toward the 1.20 – 1.21 resistance area which could form the right shoulder of a large head and shoulders pattern which could see a much deeper move lower over the coming months.