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European session – ECB lets down traders expecting more stimulus; euro rallies

The euro rallied in later European trading today as the ECB failed to live up to the expectations that had built up before today’s meeting.  In the event, the ECB did cut its deposit rate deeper into negative territory by 10 basis points to -0.30%, extended its QE program to March of 2017 and broadened the scope of the program to include local government and municipal bonds.  Crucially though, the bank failed to enlarge the size of its monthly purchase program, although it did promise to reinvest the proceeds from bonds that mature.

Expectations coming into the meeting had been high and the disappointment resulted in a big squeeze of the crowded euro short positions, driving the euro much higher versus the dollar (1.0810), the pound (0.7190) and the yen (133.30).  As an indication of the size of the move, the euro rose by more than 300 pips from its level before the ECB announcement before giving up a few of the gains.

In other economic news, the final Markit PMI for the Eurozone was revised lower to 54.2 from 54.4 (preliminary) as a result of a downward revision of Services’ PMIs particularly in countries such as Italy and France.  Eurozone retail sales for October also disappointed by coming in at -0.1% month-on-month versus 0.2% expected.

In the UK, a stronger-than-expected Services’ PMI for November did little to help the pound, as apparently the price component was relatively weak.  The Bank of England Governor Mark Carney said recently that the bank would focus mostly on its inflation target and leave financial stability issues to the Financial Policy Committee, which would use targeted macroprudential measures such as higher bank capital ratios.  Nevertheless, the pound managed to gain versus the US dollar as the greenback was sold – particularly against European currencies – following the ECB’s failure to meet up to expectations of additional stimulus.

In the United States, weekly jobless claims were in line with expectations at 269 thousand.  The non-manufacturing ISM survey disappointed on the other hand by coming in at 55.9 versus 58 expected and 59.1 previous.  The employment and new orders components were particularly weak.  The fact that both the manufacturing and non-manufacturing surveys showed a sharp slowdown during November could be a warning sign but not enough data is out yet to make this worrying.  The weak ISM seemed to have a somewhat negative effect on the dollar.  Factory orders were slightly better-than-expected at 1.5% month-on-month following the previous month’s -1% drop.

In prepared remarks in testimony before Congress, Fed Chair Janet Yellen more or less repeated her most recent comments about the economy saying that she expects inflation to rise from its current depressed levels during 2016 and that the Fed would carefully evaluate a range of indicators before deciding about interest rates in two weeks’ time.

The markets will now quickly shift their attention to tomorrow’s US employment report for November, which is expected to help shape the expectations as to what happens to US monetary policy after the December meeting.

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