EUR Rising as Draghi Talks Monetary Policy Reversal

The EUR recently received a welcome boost from European Central Bank (ECB) president Mario Draghi. The EUR has been appreciating sharply in 2017, and thanks to the strong performance of the German economy, Draghi is considering tapering monetary policy in the not too distant future. The European Central Bank has been pumping upwards of €60 billion per month into the European economy. The ECBs exit strategy towards monetary policy normalization will be phased in gradually.

The ECB will continue with the current policy of monetary easing through Q1 2018. After that, it will start phasing out the quantitative easing program between January and September 2018. By early 2019, the ECB will likely implement its first rate hike. This will be the first time that the ECB has reversed course since the global economic recession of 2008/2009. The ECB currently holds an estimated €2 trillion of debt and Draghi is likely to implement a policy of flexible purchases.

Leading economist from Weiss Finance Nathalie Goldman expects Draghi to announce lower QE amounts in October 2017.

‘Our modeling suggests that given the current state of the European economy, we can realistically expect the ECB to announce changes to quantitative easing in October. By Q1 2018, we expect quantitative easing to begin, and it will likely take 9 months to kick in. Asset purchases are likely to continue through January 2018. My colleagues anticipate that we will see a gradual unwinding of asset purchases, in an incremental fashion. As far as rate hikes go, it’s a tough call.

If the ECB decides to increase interest rates – and there is no reason to expect that they won’t – this will only take place after 2018. We will have a much clear indication of ECB policy once it begins tapering asset purchases, and only then will we have anything to interest rate movements. The current fixed interest rate for deposit facilities is -0.40%, and for marginal lending facilities is 0.25% – both historical lows. Any increase to the interest rates will cause the EUR to appreciate rapidly, relative to the GBP, USD, JPY and others.’

UK Construction Data Hamstrings the GBP

The UK economy has also been beset with additional problems, other than Brexit-related stresses. The services PMI and factory output figures have disappointed somewhat, and economists point to the weakening of the GBP as the UK construction growth hit its weakest level in 11 months. The GBP reversed direction recently against the EUR, and is moving towards parity.

Recent Brexit negotiations between the UK and the EU hit a dead end as the third round of talks concluded. Any hopes of a trade deal and blueprint for Brexit faded as European intransigence to accommodate UK interests continues. The EUR has extended gains against a basket of currencies, and is pushing towards its 21 daily moving average level of 0.9151. The UKs IHS market construction PMI dropped to 51.1, down 0.8 points from the July figure of 51.9.

While Brexit fears remain a source of concern, they have been put on the back burner as asset managers scramble to forecast the GBPs performance over the Q4 2017. The focus is now on the fundamental aspects of the UK economy, and on monetary policy (interest rates and stimulus). Various trade possibilities exist with a weaker GBP, notably higher export volumes, and increased revenues for the UK travel and tourism industries.

Analysts are looking at the GBP from two opposing perspectives: On the one hand the GBP has been bombarded from all sides and is technically undervalued. At the same time, the long-term prognosis for the GBP is negative, given that the fundamentals of the UK economy are weakening (rising import costs, stagnant real wage growth, capital flight etc).