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Euro Drops on ECB Comments but Markets prefer Action to Talk

Posted by Joseph Trevisani on Mar 11, 2014 11:56:00 AM

The euro slipped its lowest level against the dollar in three days after an ECB comment that the market may have missed part of the banks message on forward guidance.

The united currency dropped to 1.3832 from an opening high of 1.3877 after European Central Bank Vice-President Vitor Constancio said "The forward guidance was made more precise in relation to the existence of this slack. Unfortunately ... this was not picked up by the markets." The euro had recovered about half the fall by mid-afternoon on Tuesday.

Mr. Constancio was referring to the output gap in the eurozone economy, the difference between the amount of goods and services the economy could produce and what is actually being made.  The euro had reached a two and a half year high against the greenback at 1.3915 on Friday.

Mr. Constancio, the former head of the Portuguese Central Bank, noted that the central bank still had policy options such as lower interest rates or quantitative easing if needed.

 ECB President Mario Draghi has mentioned the possibility of negative interest rates on excess commercial deposits at the ECB and halting the sterilization of bond purchases as other possible methods of promoting bank landing and supporting the economy.

At last Thursday's policy meeting the bank left its main-refinance rate unchanged at 0.25 percent. It did not end its weekly bond sterilization sales, which had been widely expected, because inflation has been less than half the ECB target of just below 2.0 percent since last October and at 0.8 percent annually in February is just 0.1 percent above the non-recession low.  The euro promptly raced to its high when the bank did not act on sterilization.

Mr. Constancio said it is a mistake to assume the bank rate policy is on hold. The ECB, he noted, can still cut rates, implement quantitative easing or buy assets, though the political implication of these policies across the euro zone and especially in Germany makes them far less than certain.

The reluctance of the ECB to act on policy options outside of interest rate adjustment despite often mentioning the alternatives has been one main factors behind the strength of the euro. Since bottoming last July 9th at 1.2755 the united currency has gained 8.7 percent against he dollar.

The stronger euro makes European exports outside the EMU more expensive and inhibits economic growth particularly in counties with relatively low value-added industries like Greece and Portugal and to a lesser degree Spain.

The ECB has been talking about alternatives to interest rate policy since the summer, but has failed to do anything.  In the currency markets, talk only goes so far.

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Alpha Trader

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