Mario Draghi is one of the better communicators in modern central banking. Everything he conveyed during the ECB’s 19th of January press conference was intentional. Each time he was presented with questions about whether the ECB should consider winding down its bond buying program faster in light of strengthening economic and inflation data he repeatedly stated, “it wasn’t discussed.” The last thing the native Italian central bank chief wants is a market eager to front run an accelerated QE taper, causing an unstable spike in Eurozone bond yields and in the value of the euro. Any tiny crumb of hope tossed to the hawks risks massive market repercussions similar to the Bernanke-inspired taper tantrum of 2013. Maintaining ultra loose monetary policy risks a rubber band snap back toward tightening the instant the tension is relieved.
ECB’s Nowotny took the prevailing dovish tone a step further today by saying the ECB won’t discuss tapering at the March meeting either. Euro currency pairs quickly dropped 50 pips. But the move was short lived. The euro boomeranged right back up and then some. It is proving difficult at the moment to sustain EUR/USD below 1.07 without a new politically inspired catalyst. So what happened? Why are dovish ECB comments from officials either not effective or even counterproductive in the sense they are actually boosting the euro?
The ECB is undoubtedly behind the curve in tightening monetary policy. Markets know it. Inflation is sharply advancing higher in Germany to the point where it has been front and center headline news in the newspapers. Germany may be known for outsized fears of inflation but this time it is correct to have such views. Wholesale inflation (PPI) is gapping higher at an even faster rate in global regions which typically lead the others – China to name a big one.
If you believe as I do that the ECB is behind the curve in tightening monetary policy then you’d also believe digging in with continued dovishness puts it even further behind the curve. As long as you think the ECB has enough credibility to eventually catch up in the tightening cycle then the more dovish it is now, the faster it will have to tighten later to catch up. Dovish statements and actions will only strengthen the euro at this point because it raises the bar for how fast the ECB will need to tighten later. The only issue waiting in the wings with the potential to drag down the euro in a big way is anti-EU political risk. Consider monetary policy jawboning to be rendered ineffective or even counterproductive from here on out in inflicting losses to the single market currency. ECB dovishness will only boost the euro further.