On Thursday the eyes of the financial world were on the European Central Bank (ECB), specifically the bank’s President, Mario Draghi.
After months of speculation over what the ECB may or may not do with it its asset purchase program, Draghi delivered a masterclass in central banking, managing to send the euro and euro-area bond yields sharply lower, and stocks higher, despite halving the size of monthly asset purchases from January next year to €30 billion.
He announced a reduction of its quantitative easing program, but the markets reacted as if it was increased.
Quite the performance. Houdini like, in fact.
As Greg McKenna, chief market strategist at AxiTrader, wrote in his market wrap, Draghi managed to turn what was ultimately a hawkish move from the ECB into something that was perceived as dovish.
“Draghi highlighted that he expects ‘rates to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases’, but the key was the open ended commitment to QE if necessary after the new program ends in September 2018, with the addition of the crucial words ‘or beyond, if necessary and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with inflation aim’,” McKenna says.
That is, while Draghi announced that monthly asset purchases will be halved to €30 billion between January and September next year, it could still be extended if inflation trends over that period move in an undesirable direction.
And, on top of not committing to ceasing asset purchases by September next year, Draghi said that asset purchases could even be increased.
As Mckenna notes, this really provided the kicker to get the markets moving, underlining the vastly differing policy stance between the ECB and US Federal Reserve over the year ahead.
“The ECB is a single mandate entity — inflation only,” Mckenna says.
“And Draghi signalled that if the outlook for inflation becomes ‘less favourable’ the ECB ‘stands ready’ to increase QE once more if required.
“By refocusing attention on inflation, and the ECB’s mandate while at the same time reducing the bond buying program Draghi has successfully walked the minefield traders set for him.
“Draghi has emphasised a clear policy divergence between his ECB and the Fed, one which markets, traders, and investors weren’t as committed to because EU area growth has improved so much this year.”
A policy divergence that markets weren’t committed too, or positioned for, resulting in the sharp moves in financial markets on Thursday.
As McKenna described Draghi’s press conference, it was “pretty dovish stuff”.
“No wonder euro-areaa bond and stock markets rallied. And no wonder the Euro got hammered down and through support at 1.1660/70,” he says.
It was a masterclass in Central Bank speak, turning a tricky pivot point for ECB policy that, at least in its initial stages, has delivered the optimum outcome for the eurozone economy.
The full Q&A from Draghi’s press conference can be accessed here.
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