The European Central Bank (ECB) stepped up its efforts to boost both growth and inflation in the Eurozone on Thursday.
Nearly two years after the launch of quantitative easing back in January 2015, the ECB announced it would be extending its horizon beyond the previous March 2017 end date. The ECB will now continue its asset purchases until the end of December next year or beyond, if necessary. This is a longer extension than the market had been anticipating.
The Governing Council will continue purchasing 80 billion Euros a month up until the end of March, though announced it will be lowering the monthly purchases to 60 billion Euros for the remainder of the 2017. This increase in the ECB’s QE programme is significant in nature and will now see an extra 540 billion Euros pumped into the Eurozone economy.
The magnitude of the extension in the QE programme took the market by surprise, given it had priced in only a six month extension. President Mario Draghi also sent out a very dovish message in his press conference. Draghi insisted that the recalibration of the asset purchases did not constitute tapering. Further, he stated that “tapering”, defined as a slowdown on the pace of purchases towards zero, was not even discussed by the Council.
The ECB’s general outlook was even more dovish. The statement suggested the size of the asset purchases could be ramped up should “the outlook become less favourable or if financial conditions became inconsistent with further progress toward a sustained adjustment of the path of inflation”. We ourselves were surprised that updated forecasts for both growth and inflation were little changed, with the ECB not expecting headline inflation to return to target until 2020 at the earliest. The ECB is discounting almost entirely the inflationary impact of rebounding commodity prices.
Currency traders reacted accordingly to Draghi’s dovish surprise, sending the Euro crashing sharply lower by over 1.5% against the Dollar, and a similar amount against Sterling (Figure 1).
Figure 1: EUR/USD & EUR/GBP (08/12/2016)
Source: Thomson Reuters Date: 08/12/2016
What’s next for the Euro?
Since Donald Trump’s shock election victory at the beginning of November, the single currency has fallen sharply in value as the prospect of ramped up fiscal spending, large scale tax cuts and higher interest rates in the US next year caused investors to pile into the US Dollar. Even before today’s ECB meeting the Euro had fallen to its weakest position in 21 months against the Dollar in the immediate aftermath of the Italian referendum result (Figure 2).
Figure 2: EUR/USD (January ‘16 - December ‘16)
Source: Thomson Reuters Datastream Date: 07/12/2016
The Euro has come under heavy pressure from the uncertain political landscape in Europe. The Brexit vote in June and, of course, Donald Trump’s election in November, have reignited concerns of a rise in support for Eurosceptic, populist parties in the Euro-area. Presidential and general elections in France, Germany, the Netherlands and now possibly Italy in 2017 all add to an uncertain year of politics in Europe.
We think the Euro will continue on its downward trend in the coming weeks and months. We believe the ECB’s surprisingly large extension of its QE programme, coupled with the uncertain political landscape and strong US Dollar under Donald Trump’s presidency, will drive the Euro towards parity with the greenback. We remain of the opinion that the Euro will reach parity with the Dollar in the first quarter of next year, while depreciating by a similarly sharp degree against Sterling.