ECB watching money markets closely – EUR/USD falls

After the ECB left the rates unchanged for a second month in a row, Mario Draghi faced the press amid growing concerns that inflation is falling to dangerous levels. He said that the ECB is monitoring money markets closely, and this has a negative impact on the euro. He also promised to use any tools allowed by the treaty, if necessary. The stronger forward guidance and the explicit warning about money markets and low inflation have an impact on the euro.

Here is a live blog of the event which sent EUR/USD 70 pips lower, as it happened:

Highlights

Live Blog

• 13:18 GMT: Press conference begins at 13:30. All times are GMT. You can watch the press conference here.
• 13:19 EUR/USD is trading steadily at around 1.3610 towards the event.
• 13:20 The US will release weekly jobless claims at 13:30. This is the last hint towards the Non-Farm Payrolls on Friday. See how to trade the NFP with EUR/USD.
• 13:21 The press conference is held in Frankfurt, at the ECB’s headquarters. Twice a year, the meetings are held outside the HQ.
• 13:22 Latest analysis before the press conference: ECB doesn’t know its next move just yet.
• 13:24 Germany and Spain seem to do well, while France and Italy are lagging behind.
• 13:26 EUR/USD is beginning to tick higher towards the event, rising to 1.3630.
• 13:29 Draghi tends to zig zag from optimism to pessimism every month. After being cheerful in December, will be downbeat now?
• 13:30 US jobless claims fell to 330K.
• 13:30 Press conference begins.
• 13:31 Happy new year and welcome Latvia, the 18th euro member,
• 13:32 Rates unchanged. Analysis confirmed our previous analysis. Inflation expectations over the medium to long term are firmly anchored.
• 13:33 Long period of low inflation with a gradual rise.
• 13:34 to maintain an accommodative stance for as long as needed.
• Forward Guidance reiterated
• 13:34 Broad based weakness of the economy and subdued dynamics.
• 13:35 We are monitoring money markets very closely. Further decisive action if required. EUR/USD drops and loses 1.36.
• 13:36 Looking at 2014 and 2015, output is expected to recover at a slow pace.
• 13:37 Unemployment remains high. Fiscal consolidation needed.
• 13:38 Improvement in financial markets since 2012 making its way to the real economy.
• 13:38 Risks remain on the downside. EUR/USD feels the heat.
• 13:39 Inflation is subdued.
• 13:40 There is a preference for liquidity, although below previous levels.
• 13:40 Interest of foreigners in EZ investment.
• 13:41 Since the summer of 2012, banks are more stable.
• 13:41 Essential that the fragmentation is reduced.
• 13:42 AQR will help build confidence, and so will a banking union.
• 13:42 “We may experience a long period of low inflation”
• 13:42 Important not unravel fiscal consolidation, in line with the fiscal compact. This will have a positive impact.
• 13:43 Questions begin
• 13:44 Two contingencies that may trigger action: too much tightening and worse inflation.
• 13:46 Draghi explains the lack of correlation between EONIA and other figures.
• 13:47 Discussed all possible instruments.In the meantime, EUR/USD continues falling.
• 13:47 It’s hard to speculate on which tool we would use, says Draghi. All tools in the treaty can be used.
• 13:49 Draghi basically confirmed a deeper forward guidance.
• 13:51 Banks can prepare for the AQR and improve their balance sheets.
• 13:52 There is a need to counterbalance the implications of the bank deleveraging.
• 13:53 Financial markets have improved.
• 13:54 Need to repair banking system before it is too late, not to repeat mistakes made elsewhere. A fragile banking system can undermine monetary transmission.
• 13:55 A question about core inflation from the FT correspondent.
• 13:56 Draghi doesn’t answer about the instruments, and falls back to the treaty.
• 13:57 Lower inflation in December due to a statistics change in Germany. January’s figure will not be distorted.
• 13:58 The improvement is thanks to the ECB’s actions but also thanks to the fiscal consolidation. Big progress on the banking union.
• 13:59 Many look at the glass half empty, but there has been a big change in governance.
• 14:00 What’s driving money markets? Inflationary pressures to remain subdued for at least two years. This is in line with our baseline scenario. Will act when the assessment turns to the worse.
• 14:01 Money market rates depend on a variety of factors. The decision taken in November were successful in stabilizing interest rates and reduced uncertainty.
• 14:02 After the FG was issued and strengthened in November, the euro area is somewhat insulated to external pressures.
• 14:05 Unemployment remains unacceptably high, and at least it has stabilized. The recovery is there, but fragile, modest.
• 14:06 Premature to declare any victory and that’s why we are using firmer language in our forward guidance.
• 14:07 Confidence is gradually coming back. There is less fiscal drag.
• 14:08 Confidence is coming back, and 3 months ago we haven’t been that explicit.
• 14:09 Question about meeting minutes. Answer: we still are reflecting on it.
• 14:12 Important to remember we are not one country, and that we have to jealously guard our members.
• 14:13 “You cannot make the weak stronger by weakening the strong”, Draghi quotes Lincoln.
• 14:14 Infrastructure investment need to be carried out.
• 14:15 Making Germany weaker will not make the other countries stronger.  
• 14:15 Question about the efficiency about the measures and the risks.
• 14:16 There are downside risks.
• 14:16 Right now, we don’t see deflation. At the moment, we see limited upside and downside risks.
• 14:18 Some of the drops are due to the necessary rebalancing and to real deflation. We don’t see deflation in the Japanese sense.
• 14:19 In Japan, inflation expectations were not firmly anchored. This time, this place, it’s different.
• 14:20 Technically, we cannot run out of money.
• 14:21 EUR/USD is bouncing a bit back, rising to 1.3570.
• 14:23 Regarding the relations with Germany. There is a difference between perverse and perverted.
• 14:24 The euro crisis is not over. LTRO did not trigger higher inflation and the mandate was not broken. Draghi defending his interview.
• 14:25 Low inflation and low interest rates trigger angst by the older. This is a reasonable angst.
• 14:26 Draghi asked about SEPA, and EUR/USD is stabilizing. The SEPA migration is gaining momentum. It makes sense that the bigger banking systems take more time than in smaller countries.
• 14:28 Government bonds will be treated as risk free according to Basel regulations.
• 14:30 Question: was the decision unanimous? We had an extensive discussion about the state of the economy and asked what sort of risk undermines our baseline scenario? What would worsen the inflation outlook – to the downside, clarifies Draghi. What would money markets issues cause? We then discussed all the instruments. Well, Draghi refuses to answer.
• 14:31 Press conference ends

Background

The drop of headline CPI inflation to 0.7% in October triggered the rate cut to 0.25% in November. Headline CPI has since risen, but it didn’t go to far: 0.8% in December. However, German HICP year over year inflation unexpectedly dropped in December to 1.2% and core CPI in the euro-zone fell to 0.7%, lower than before the rate cut. So far,

Draghi repeatedly said that the ECB is technically ready for a negative interest rate. The effect of these words on the currency rate has been more significant at first, but is diminishing now. At some point, low inflation and a strong euro could trigger action.

For more, see the EUR/USD forecast.