26 July 2019: ECB uses the magic words

ECB uses the magic words

July 26th: Highlights

  • September rate cut very likely
  • Johnson crosses swords with Corbyn and upsets Brussels
  • GDP to have major bearing on FOMC decision

Draghi confirms that rates will remain at current or lower levels

The ECB was about as dovish as it could have been at yesterday’s meeting without telling the market the date and size of the next cut in interest rates.

Mario Draghi will now definitely be known as the Central Bank President who over an eight-year term never presided over an economy which was strong enough to survive a rate hike. In his press conference following the meeting, Draghi confirmed that should the medium-term inflation outlook remain short of the Central Bank’s aim; they are ready to act in whatever capacity necessary. He went on to give a little comfort to savers by confirming that bureaucrats are working on how the tiering of the system would work in a negative rate scenario.

He went on to say that rates were likely to stay at or close to present levels until mid-2020, confirming that he doesn’t expect any improvement in the economic environment in the short term. This was a confirmation of what the market had expected following this week’s PMI data.

The scene is now set for the euro to break through the two-year low at 1.1106. It reached a low of 1.1101 earlier in the day, but traders started to take profit on short positions unsure about Fed actions next week. It closed at 1.1144.

The fate of the single currency is now firmly in the hands of the Federal Reserve. If the FOMC cuts but remains hawkish over the economy a test of 1.1000 is still very much on the cards.

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Buckle up for a bumpy ride towards No-deal

Boris Johnson’s first full day as Prime Minister saw him clash with the Leader of the Opposition in the House of Commons. His threat over a no-deal Brexit drew a stinging response from both outgoing EU Commission President Jean-Claude Juncker as well as Chief negotiator Michel Barnier. Neither was impressed by Johnson’s “combative” approach while Juncker confirmed that the Withdrawal Agreement was the best and only deal available, a fact that Johnson disagrees with.

Johnson confirmed that he will continue to seek the removal of the “Irish Backstop” from any agreement and will withhold payment of the “divorce settlement” of £39 billion as leverage.

While Johnson and his new team have the same ultimate objective as Theresa May, their approach could not be more different. Barnier’s assessment is correct. Johnson will be more “combative” but whatever happens, Brussels will know it has been in a fight.

Following several speeches which bordered on jingoism and having appointed a Cabinet of like-minded Ministers, it is time for Johnson to start to formulate plans for how he can achieve his goal of leaving the EU on 31st October with or without a deal. If it is to be “with”, then he will need to work on the “hearts and minds” of individual nations, Germany especially, to convince them it will be better to have the UK as a friendly business-like neighbour.

The opposite will be true if there are bitter recriminations following the departure. A change in personnel in Brussels will happen too late to help the negotiations but Johnson may be well advised to curry favour with Ursula von der Leyen, the new Commission President.

The financial markets looked on with interest as Johnson’s term began. Overall the reaction was muted but positive. The fact that Johnson’s appointment will bring no-deal closer was not lost on traders. However, no deal with a plan and a Minister charged with the task of preparing for such an event has an entirely different “feel” to it.

The pound ended a little lower versus the dollar having rallied to 1.2518 earlier. It closed at 1.2455.

Data-driven Fed to get a major clue to future economic growth

Despite whatever policies they may enact, Central Banks need to give the markets a solid impression of their capacity to deal with whatever the economy throws at them. They also need to be prepared to be flexible since, despite the economy changing course in about as nimble a fashion as a supertanker once a change has started, it is very difficult to arrest.

So it proved through last year as the Fed acted both pre-emptively but also possibly a little hastily in hiking three times in reaction to President Trump’s stimulus package of tax breaks and infrastructure programmes. If the President’s actions were open to question, the reaction of the Fed was also dubious. Not only drawing a stinging reaction from the President, the hikes pushed the dollar index to new high and made U.S. exports that little bit less competitive on world markets.

Now the Fed is considering rate cuts to provide a certain stimulus to the economy despite analysts questioning the timing.

Today’s release of data on economic growth in the period between April and June will provide a definitive answer to questions over the Fed’s intentions at its meeting next week. There is unlikely to be any “grey area”. GDP at or below 2% will justify a hike while, while an upside surprise will choke off the need for anything other than a single cut.

The dollar index awaits today’s news prepared for whatever the data predicts. Not only will the FOMC have the last quarter’s data to analyse next week, but it will also have a fair idea about how the activity has changed since June 30th.

Traders remain positive about the dollar but that may have a lot to do with the alternatives across the Atlantic. Yesterday, the dollar index closed at 97.79 having reached 97.92 earlier in the day.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”