Gadfly

The Joys of ECB Procrastination

A sharp reversal versus the dollar could catch out a lot of investors.
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Photographer: Krisztian Bocsi/Bloomberg

The dollar has been on its worst run against the euro since 2011. That is a headache for the European Central Bank's efforts to stoke economic growth and get inflation back to its target -- and it's leaving a lot of investors in a vulnerable position.

President Donald Trump's political difficulties, including delays in moving forward his economic agenda, are weakening the greenback across many currencies, but it's particularly noticeable against the euro. This is partly down to the region's better growth rate, but also because the ECB is going to have to take a decision on paring stimulus before its quantitative easing program expires at the end of the year.

Certainly investors are betting the current trend will continue -- the market has a near-record long position in euro futures contracts. This could reverse sharply if the currency's direction changes. Thermonuclear war notwithstanding.

About the only realistic measure the ECB can take to temper euro gains is to delay the decision on tapering QE. This would involve not only disappointing investor expectations for an announcement at the governing council's September meeting, but also letting Federal Reserve Chair Janet Yellen be the pacesetter for major central banks on winding down QE. It would also prevent the nightmare scenario that the Fed could delay its decision on reducing its balance sheet, which investors expect to hear at its Sept. 20 meeting.

Draghi has a couple of major opportunities -- his appearance in Jackson Hole later this month and the ECB Sept 7. policy announcement -- to lay the groundwork for letting the Fed go first. He is going to have to talk around the subject -- a personal specialty -- if he wants to let the U.S. central bank do the hard yards for him on tapering QE, and supporting the dollar.

Non-action may accomplish what jawboning hasn't. Draghi made clear at the July press conference that the governing council has yet to start discussions about tapering QE. Furthermore, he's questioned whether officials will have sufficient technical detail by the next meeting to make a definite decision. Add to that a reduction in hawkish comments from within the central bank. And the euro keeps getting stronger.

There's good reason to delay, anyway. The return to growth isn't firmly established. And despite an ECB balance sheet of over 4 trillion euros ($4.7 trillion) -- core inflation has only managed to accelerate from 0.9 percent to just 1.2 percent. That's not exactly encouraging hope of a sustained pickup in consumer prices that will drive the key rate to the target of just below 2 percent and keep it there.

Add to the mix the German elections on Sept. 24, which probably will be the region's last major EU political event of the year. After all the drama around the Italian, French and Dutch votes, letting this one sort itself out first makes sense. Putting off a QE tapering announcement at least until the ECB meeting in October looks the smartest move for the wily President.  It may just leave a lot of investors in the lurch. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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