For a central bank not trying to drive down the euro, the European Central Bank is doing a pretty poor job.
That’s only fair, in that the Federal Reserve is doing a flat-out lousy job of normalizing interest rates for a central bank which says that that is its aim.
The euro dropped sharply after Mario Draghi and the ECB indicated that more QE and even lower interest rates could be on the way as early as late this year.
The euro fell more than two cents against the dollar to US$1.11, taking it back to levels it saw in August, when markets actually believed the Fed would move in 2015.
The euro is down more than 8% against the dollar year-to-date, and has fallen by 12% over the past year.
Nothing to do with Mario, of course.
“I’ve said it many times, for us the exchange rate is not a policy target,” Draghi said at the press conference following the ECB’s decision to stand pat.
“It’s important for price stability, for growth, but it’s not a policy target. The movements in the exchange rate (over) three years were the outcome of diverging monetary policy cycles as well as divergent economic recovery paths between major jurisdictions. They were not intended, it was not an action geared to cause these exchange rate movements. They were the outcome.”
In other words, it’s not that I meant to stab your hand, it’s just that it was right over my steak.
Economists weren’t buying this either:
“They do want actually to drive the euro exchange rate lower, even though history (above all the interventions of the 1980s and 1990s) shows this is totally ineffective, in fact all too often a policy which backfires,” Marc Ostwald of ADM Investor Services wrote in a note to clients, going so far as to label Draghi’s disavowal “an outright lie.”
If we judge intentions by outcomes then we can say two things about the ECB’s performance today: they aren’t being straight about their intentions, but they are, for the time being, successful.
Not only did the euro fall, but so did bond yields, reacting to what investors took to be indications that not only will QE be extended, expanded or tinkered with in December but that we may also see an even lower deposit rate.
When the ECB took the deposit rate to -0.20% last year, Draghi, you may remember, said no additional rate cut was possible.
Nice policies, shame about those results
So while it is nice to see policy-makers pushing the boundaries of the possible, the main issues facing the ECB, and for that matter the Bank of Japan and Federal Reserve, is the striking lack of strong evidence that these policies work well.
The Fed itself, though understandably keen to get interest rates up off of the zero bound before the business cycle, as it must, turns south, has thus far been unable to turn the trick. While September was once thought a done deal for a hike, March is now only seen as a 50/50 chance.
There simply doesn’t seem to be much evidence that QE and zero rates have done much to drive inflation higher.
Today’s market response was driven in part by the faith traders have that QE is effective, if not in the real economy, then at least in financial markets, particularly currencies.
Kit Juckes, strategist at Societe Generale in London, disagrees: “I am doubtful that increased conventional QE (bond-buying) by the ECB or the BOJ will weaken the yen or the euro significantly further from their recent lows. Indeed, I’m not sure how much of the weakness in either currency to date can really be attributed to QE in the first place,” he writes.
While QE in the US may have hurt the dollar by driving flows to emerging markets, which in turn drove emerging market central banks to both intervene and to buy Treasuries, elsewhere other factors came into play. The ECB and BOJ achieved what devaluation they have by, in Japan a switch to overseas equities among savers, and in Europe the introduction of negative rates.
Still, the market salivates and sells euros when Draghi says QE. If he doesn’t follow up with the meat of a further reduction in interest rates, the response may fail next time.
As always, give more weight to what central banks do than to what they say.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
