The stimulus measures announced by ECB President Mario Draghi, together with the reduction in the deposit rate to -0.30%, left markets underwhelmed on Thursday. This caused a huge rally in the euro – the biggest such daily move in 6 years.
What were the reasons for the market’s big surprise though? Although it is hard to speculate on exactly why this happened, it appears that a combination of miscommunication, false perceptions and some infighting within the ECB Governing Council could have led to this outcome.
Firstly, the miscommunication refers to that Draghi’s speeches and appearances led to expectations of something bigger than what was eventually delivered. Particularly versus the dollar, the euro faced unrelenting pressure and significant losses during the month of November. Draghi and other ECB council members also refrained from moderating market expectations, which might have been a missed opportunity on their part.
Secondly, following the announcement of the bigger-than-expected QE program back in January and indeed ever since Mario Draghi took over as ECB President, he gained a reputation for smooth communication with the markets. Draghi was like a listed company and a market darling announcing earnings; regularly ‘beating’ expectations after massaging them to the right degree. This time round, it appeared that Draghi was not able to meet or surpass expectations and hence the big negative reaction from the market (actually buying back the euro).
Thirdly, it is clear that not all the ECB board members were on board for a more substantial stimulus increase. Some newspaper reports mention that 5 out of the 25 council members objected to even the watered down stimulus measures that the market felt disappointed with. It looks like the more aggressive stimulus measures that the market would like to see, might have been much more divisive for the Governing Council. This is especially in light of the fact that the Eurozone economic outlook had not deteriorated so substantially lately so as to warrant drastic action. Yes inflation was looking low but the core rate around 1% was not a complete disaster.
Finally, concerning the foreign exchange market, prior to the ECB announcement, it looked like a boat in which all passengers rushed to one side. This made the market and the positioning very unbalanced as most speculators were short the euro and consensus sentiment was very euro negative. At least following the previous day’s events, the market is looking more balanced – although the euro bears and consensus sentiment are still looking for the single currency to head lower.
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