Draghi's Soft Euro Talk Suggests He's Holding Back the Magic

  • Currency rises above $1.20 after ECB president notes concern
  • Remarks ‘could have been more forceful,’ analyst says

Examining Mario Draghi's Relationship With the Euro

Mario Draghi’s words on the euro seem to have lost a bit of their magic, but maybe he wasn’t trying very hard.

Despite a rare mention of the currency’s appreciation the European Central Bank president’s opening statement, an escalation from the account of the last meeting when policy makers noted their collective concern, the euro rose on Thursday. Aside from admitting that the exchange rate’s “volatility” is problematic, he declined to talk about any action to reverse the course.

“The strategy of this soft intervention is to prevent further speculative upward pressure on the euro,” said Lena Komileva, an economist at G Plus Economics. “Draghi didn’t seem overly concerned.”

The euro’s continued gain as Draghi spoke stands in contrast to its tumble in May 2014, when the ECB president signaled “serious concern” about the the exchange rate. The difference then was that the economy appeared fragile and the euro was approaching $1.40.

In August, the euro spiked above the $1.20 mark for the first time in two years after Draghi avoided mentioning it in Jackson Hole. Addressing it on Thursday may have just been enough to discourage traders from pushing it even higher. It may also stop the issue from interfering too much in the debate on how to start winding down bond purchases in 2018.

Draghi was questioned about the currency at least half a dozen times. While he admitted that there was “broad” concern in the Governing Council over the euro, he said the the currency merely warranted “monitoring,” stopping short of stronger verbal interventions.

“Draghi could have been more forceful on the euro,” said Marco Valli, an economist at Unicredit in Milan. “But the Governing Council seems to think that at least part of the appreciation is a consequence of the economy’s strength. Therefore, sounding too concerned would have not been credible.”

There is a solid economic case for the euro’s rise. The ECB upgraded its forecast for growth this year to 2.2 percent, the fastest pace in a decade, and left it unchanged for 2018 and 2019. At the same time, the reduction in the outlook for inflation was small -- much less than would have been warranted by looking at the 4.4 percent appreciation in trade-weighted terms since the last forecasting exercise.

“An exchange rate shock of the magnitude observed in recent months would have a non-negligible impact on the outlook for euro area inflation,” the ECB staff wrote in an analysis attached to the projections. “The recent appreciation, by contrast, is likely to have been triggered in large part by the further improved outlook for economic growth in the euro area, which in turn reflects improved prospects for domestic demand.”

Draghi said that policy makers’ “broad dissatisfaction” on sluggish price gains was “tempered by the confidence that inflation will eventually converge with our objective.” He implied that a reduction of monetary stimulus in 2018 remains on track, with the bulk of decisions to be announced next month. 

Officials started discussing the re-calibration of asset purchases this week, even if they just examined scenarios and didn’t consider definite policy options.

For a timeline on the ECB’s possible exit from QE, click here

And as usual, Draghi’s silences were just as telling as his words. When asked about tapering, he stressed that changing the sequencing and issuer limits weren’t on the table. Notably absent from the list of what was off-limits: the capital key, which dictates how purchases are divided among countries.

The ECB’s scenarios for its asset purchases after 2017 could be implemented without adjusting the parameters of the program, according to euro-area officials familiar with the matter. The bond-buying options presented to policy makers this week involved combinations of monthly volumes and durations that all stick to existing limits, the people said, asking not to be named as the Governing Council’s deliberations are confidential.

As the program goes ahead and the risk of scarcity becomes more concrete, Draghi said they will always find a way to make the bond plan work.

“I’m pretty confident that when the policy decision times comes, we’ll certainly be able to exploit all the flexibility that the program has in its construction,” he said.

— With assistance by Fergal O'Brien, Catherine Bosley, Zoe Schneeweiss, Carolynn Look, Lucy Meakin, Jill Ward, David Goodman, and Stephen Spratt

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