Euro falls as ECB keeps rates on hold

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Euro falls as ECB keeps rates on hold

The European Central Bank decided to keep interest rates unchanged yesterday, prompting the euro to drop by 0.6% against the dollar.

Christine Lagarde, president of the ECB, sought to reassure that: "We're not going to just stand still."

"We are going to use all the instruments that we have with the entire flexibility that we have, and I'm clearly here referring here to the PEPP more than others, to address the situation," she said.

It is unclear at this stage whether expanding the Pandemic Emergency Purchase Programme (PEPP) will be the best course of action in this context."

"We have done that in the past, we have responded very promptly, very appropriately, very heavily, some would say, to the first wave that hit the euro area economies. We have done it for the first wave and we will do it again for the second wave. But don't assume it will be one instrument. We're going to look at all of them," she added.

The latest move from the ECB was broadly in line with what industry commentators are saying. Here's a round-up:

Andreas Billmeier, sovereign research analyst at Western Asset commented: "In today's Governing Council meeting, the European Central Bank (ECB) kept all rates and other policy instruments at current levels but provided the market with a very pointed heads-up for the next meeting in December when it "will recalibrate its instruments, as appropriate."

At that point, the new macroeconomic projections will be able to take into account the significant undershoot in (core) inflation relative to the September forecast, as well as the impact of second-wave lockdowns. The forecast will also be more specific on the fiscal impulse incorporated in eurozone members' 2021 budgets which entail a particular amount of uncertainty this year due to the pass-through from the European recovery fund.

"In noting that the risks are 'clearly tilted to the downside,' the ECB set up expectations for action in December along a couple of dimensions. First, it could do more to support credit provision to the economy. Second, to ensure convergence of the inflation projection to the target, asset purchases are likely to have to increase. This, in turn, would support bond valuations, or at least prevent a rapid rise in interest rates, similar to the ECB's intentions in spring. It is unclear at this stage whether expanding the Pandemic Emergency Purchase Programme (PEPP) will be the best course of action in this context."

Hinesh Patel, portfolio manager at Quilter Investors, said: "The European Central Bank has taken this moment to announce it will "recalibrate its instruments, as appropriate, to respond to the unfolding situation". It was clear the economic recovery was going to be protracted as cases remained prevalent, and as such the ECB has had to pull forward the support we expected in the coming quarters and potentially years. We expect they will need to do even more. 

"The ECB is looking increasingly maxed out when it comes to "traditional" monetary policy. This is why fiscal support is so important for the eventual post-covid-19 world. They have done an okay job at keeping national borrowing rates low within the Eurozone and there's no reason to doubt their resolve for the next few years. They may just need to become a little more creative. 

"They are trying to fight disinflationary pressures within the monetary union and if average inflation targeting becomes the policy we could ultimately see stimulus heading to the same levels the Japanese have been deploying over last couple of decades."

James Sym, manager of the ES R&M European Fund, commented: "Lowering rates was always unlikely - that policy mechanism to stimulate demand is totally exhausted and the ECB understands that the negative effects, for example on the banking system, outweigh any minor signalling benefit. Other monetary policy measures will be preferred such as asset purchases and direct support for banks and SMEs." 

"Looking at the big picture, it's clear that monetary policy in this upcoming economic cycle will no longer operate alone. There will be a combination of the central banks maintaining the ‘plausible deniability' of independence while creating conditions for governments to borrow at will and spend aggressively. This is done in the hope this will close output gaps sufficiently to start to embed reflation and therefore address what has to be the biggest fundamental issue with our economies today - inequality."

"After the end of austerity in 2018, we were at a tipping point for more positive wage inflation at the end of 2019, but Covid changed everything in the short term. However, it almost certainly supercharges the need and likelihood for this policy mix for the business cycle just starting. The Powell Fed most certainly gets this. The question is, does a Lagarde led ECB?"

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Christopher Copper-Ind

Christopher Copper-Ind is editor-in-chief of International Investment. Before this, he was editorial director of The Business Year, from 2014 to 2017.