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Lagarde: There is no need to overreact to euro gains

Comments from Lagarde in the ECB opening statement:

Lagarde Sept 10
  • Says ECB will monitor FX rate
  • Strength of recovery remains surrounded by uncertainty
  • Rebound broadly in line with previous expectations
  • Domestic demand recorded significant recovery
  • Uncertainty weighing on consumer spending and business investment
  • Inflation dampened by energy prices
  • Ample monetary stimulus remains necessary
  • Incoming data suggest notable recovery in consumption
  • ECB will carefully assess the euro’s effect on inflation
  • New infections are a headwind to the short term outlook
  • Repeats that an ample degree of easing needed
  • Fiscal measures should be targeted and temporary
The euro jumped to 1.1891 from 1.1850 on the headline from Lagarde.

ECB leaves rates unchanged, as expected

ECB continues to reiterate stands ready to adjust all of its instruments

ECB continues to reiterate stands ready to adjust all of its instruments
  • Full statement
  • Prior statement
  • Interest rates to remain at present or lower until it has seen inflation outlook robustly converge to a level sufficiently close to but below 2% within its protection horizons (repeat)
  • No change to rate tiering multiplier
  • Will continue purchases under PEPP with a total envelope of 1,350B euros
  • Will continue to fully invest maturing securities at least through end-2022
  • PEPP will run at least through end of June 2021
  • The ECB cites ‘very high takeup’ of TLTRO-III
  • In its June forecast the ECB saw GDP down 8.7% in 2020 and up 5.2% in 2021
There are no changes here whatsoever. The euro chopped around 1.1400 on the release but has ticked up to 1.1410 since.

ECB meet this week (preview) but they are already driving the higher euro

As was noted during the US time zone, EUR/USD pierced 1.14. A factor that appears to have flown under the radar is this sign of (continued) aggressive policy support from the ECB, that is:
  • ECB corporate bond-buying was up 3.3bn EUR last week, which is around 400m higher than the previous record high over the past 4 years operation of the Bank’s corporate bond purchasing program
ps, ICYMI, the EU Recovery Fund will be the discussion point of note for markets in the ECB meeting Thursday
  • financing totalling up to EUR750 bn, split between grants of EUR500 billion and loans of EUR250 billion
  • Netherlands, Austria Denmark and Sweden want to reduce the amount of funds distributed as grants

Risk ahead for the EURO this week

ECB policy review and European summit

German bunds were trading at -0.46% yesterday on the 10 year chart which is 10bps lower than a Bloomberg modelled curve mentioned on the Bloomberg Live Blog yesterday. This is most likely due to positioning ahead of the European Council’s summit.

On Friday and Saturday of this week EU policy makers will meet to discuss the proposed €750 billion recovery plan.The big questions is whether nations like Austria, Denmark, Sweden, Netherland and Finland will block the plan. The  issue is that these countries are opposed to the idea of large handouts on principle.However, despite their reluctance, the present crisis means their reticence may be seen as mean spirited in a time of shared humanitarian crisis. The pressure is for the countries concerned about the ideas of grants rather than loans to approve this proposed fund.On July 10 we had a German official state that Netherlands is unlikely to block the EU recovery fund which is supportive of the fund being accepted.

On Thursday we have the ECB rate meeting with little change expected. With the PEPP program increasing by €600 billion euros last month  it is unlikely that we see any changes to the PEPP program on Thursday.

The risk

If the recovery fund is rejected by the frugal four expect immediate downside for the EUR. However, given that the second day of the meeting is taking place over the weekend this is going to be weekend risk for the EUR.

ECB policy review and European summit

Here’s a EUR/USD forecast (to 1.15) with the ECB expected to be optimistic this week

The European Central Bank meet this week, preview below.

  • Meeting Thursday 16 July 2020
  • Policy announcement at 1145GMT (policy likely unchanged)
Euro forecast via Danske (this from late last week):
  • We remain constructive and expect the broad USD to decline over the coming months
  • 3 month forecast is 1.15
On the upcoming ECB policy meeting
  • we expect a repetition of recent comments from various governing council members, thereby striking a cautiously optimistic tone compared to the June projections. 
  • We also expect they may decide not to use the EUR1,350bn PEPP envelope in full. 
  • No new initiatives are expected next week
  • Markets may not be prepared for a ‘less dovish’ message
  • with abundant liquidity, PEPP and APP still ongoing
  • Our key expectation is that the ECB will reiterate its stance towards supporting a recovery, with, not least, a focus on sovereign spreads. 
For spot FX,
  • the direction and stance of the ECB and euro area fiscal politics are, in our view, quite well priced and communicated (though to a lesser extent when it comes to the outcome for Brexit). In turn, it will be the breath and speed of the global recovery that sets the tone in EUR/USD, and mostly through the USD leg

European Central Bank preview

EU could open legal case against Germany over ECB bond-purchases ruling

Last week Germany’s constitutional court issued a decision ruling that the European Central Bank had overstepped its mandate with QE bond purchases,

  • German court in Karlsruhe gave the ECB 3 months to justify its euro zone QE stimulus programme, or the Bundesbank might have to step aside from it
Responding, the European Union’s highest court (which had previously permitted the ECB QE programme) and the European Commission said that EU law holds precedence over national regulations
Further now, on Sunday, EU Commission President Ursula von der Leyen said the EU executive might end up opening a legal case against Germany.
  • “We are now analysing the ruling of the German Constitutional Court in detail. And we will look into possible next steps, which may include the option of infringement proceedings,”
These wort of legal wranglings are not a positive for EU coherency and stability. Nor are they positive for the EUR. Watching for developments on this front – both legal/political and for ECB actions ahead.
 Last week Germany's constitutional court issued a decision ruling that the European Central Bank had overstepped its mandate with QE bond purchases,

ECB has given the middle finger to the German constitutional court

You’ll recall from earlier this week that the court ruled the European Central Bank must ensure its QE bond-buying program is proportionate or else Germany’s Bundesbank central bank may no longer participate.

  • And if its not the Germany Bundesbank central bank may no longer participate
The Governing Council of the ECB responded with a “Yeah, right …”:
said it “takes note” of the judgement
  • “The Governing Council remains fully committed to doing everything necessary within its mandate”
One member (at least) said the ECB will not respond directly to the court
  • court’s arguments are ridiculous
  • we could easily answer them
  • we should not do so as this is a risk to central bank independence
So, its an ‘as you were’ for the ECB QE program.
You'll recall from earlier this week that the court ruled the European Central Bank must ensure its QE bond-buying program is proportionate or else Germany's Bundesbank central bank may no longer participate.

German judges partly dismiss ECB QE case

The judges reach a 7-1 ruling in the ECB QE case

Despite the ruling, the court says that some action by the ECB QE program partially violates constitution and that some of the action is held illegal i.e. not valid in Germany.
Adding that the ECB decision is not backed by the EU treaty. The decision can be found here.

Although there are some caveats, I wouldn’t look too much into this. This just reaffirms that PEPP is going to be untouched, so the lack of suggestive price action means ‘let’s move on’.
I would argue that this is the key passage to take note of in the ruling above:

“Following a transitional period of no more than three months allowing for the necessary coordination with the Eurosystem, the Bundesbank may thus no longer participate in the implementation and execution of the ECB decisions at issue, unless the ECB Governing Council adopts a new decision that demonstrates in a comprehensible and substantiated manner that the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the programme. On the same condition, the Bundesbank must ensure that the bonds already purchased and held in its portfolio are sold based on a – possibly long-term – strategy coordinated with the Eurosystem.”

Heads up for Tuesday in Germany – court decision could place limits on ECB action

Coming up today, 5 May 2020 ,Germany’s constitutional court (in Karlsruhe) will announce its decision on whether the ECB’s public sector purchase QE program is legal under German law.

It seems likely the decision will accept the program as legal but it could nevertheless impose restrictions on what the ECB does
  • ie. it may impose conditions for the ECB’s sovereign bond purchases that could impact the flexibly of policy.
Could be a EUR negative or at least prompt some volatility. A heads up.
Coming up today, 5 May 2020 ,Germany's constitutional court (in Karlsruhe) will announce its decision on whether the ECB's public sector purchase QE program is legal under German law.

ECB leaves rates unchanged, announces new LTRO, expands QE by 120B

ECB announces measures

No changes in any rates
  • ECB raises monthly bond purchases by 120B by year-end (not per month)
  • Additional LTROs will be conducted to provide immediate liquidity
  • Says considerably more favourable terms will be applied during period from June 2020 to June 2021
  • Rates on new LTROs will be 25 bps below average rate applied in eurosystem’s main refinancing operations
  • Raises amount taht counterparties can borrow in LTROs to 50% of their stock of eligible loans
  • Continue to expect QE programs to run as long as necessary and end shortly before ECB ready to raise rates
The market was sniffing around for an interest rate cut and it didn’t come. The euro has risen