EURUSD remains under pressure is now trading below its 200-day SMA (1.3640) at around 1.3600 after disappointing German employment and EZ data weighed on the single currency yesterday morning. ECB data showed that lending to households and firms in the Euro zone declined further in April by 1.8% from the same month one year after a contraction of 2.2% in March.
Moreover, the annual growth of M3 (money aggregate, definition here) declined strongly to stand at 0.8% (from 1.1% in March and vs. expectations of 1.1%) and stands well below the ECB’s target of 4.5% as you can see it on the graph below (which represents the historical path of M3 money aggregate in yellow and annual inflation in green since 2003).
Why is M3 important? If we have a look at one the ECB’s earliest Press Releases (December 1st, 1998) – The quantitative reference value for monetary growth – it stated that the Governing Council of the ECB agreed then on some details of the reference value:
- ‘it will refer to the broad monetary aggregate M3’
- ‘Governing Council decided to set the first reference value at 4.5%’
The graph above shows us that there is a relationship between inflation and M3 growth, therefore we could see still see a weak annual inflation next week on June 3rd (expected to come in at 0.7%). In addition, the HCIP (Harmonized Index of Consumer Prices, which enables international comparisons of inflation rates to be made between member states within the EU) of the core – ‘healthy’ – countries stand currently at very low levels. For instance, Germany HICP came in at 1.1% in April, up from 0.9% the previous month but down from 2.9% in August 2011. And in order to regain competitiveness, the peripheral ‘stressed’ countries are required to show a lower inflation than the core ones, which increase the risk of deflation (Spanish and Italian annual inflation stand at 0.3% and 0.6% respectively, while Greece and Portugal are already facing deflation).
ECB’s option at next meeting: All-in or non-event?
From now on, traders and investors will be focused on one of the most important events of the year: the ECB meeting on June 5th. After Draghi announced in his last press conference in Brussels that the ECB officials were ready to act at the next meeting, the question is now ‘what are the options?’ While a cut in the refi rate (10-15bps) is largely priced in by the market and will have little or no impact on both the Euro and the inflation rate, could it come with a cut in Deposit rate (which currently stands at 0%) and/or an asset-purchase program?
The effect of a negative deposit rate (10 bps cut), which means that ECB would charge banks for parking their money at the central bank rather than lending it, remains pretty much obscure and not the best option to encourage banks to lend more. It could potentially weigh on the single currency in the short term, which isn’t the ECB officials main objective (As a reminder, ECB’s Forum on Central Banking in Portugal, Draghi said: ‘What we need to be particularly watchful for at the moment is, in our view, the potential for a negative spiral to take hold between low inflation, falling inflation expectations and credit, in particular in stressed countries’).
Therefore, if we see an action, it will probably combine a refi rate cut with an unconventional measure according to some analysts. There are several monetary policy instruments that the ECB can apply in times of extraordinary market tensions, from a full-allotment of liquidity provision (fixed rate) to a longer-term liquidity provision (LTRO) or private/public QE.
Firstly, the fixed-rate full allotment, which allow stressed banks to access unlimited ECB liquidity at a fixed rate in return for collateral, will probably be extended (until this summer at least) and would leave the marginal lending facility, an overnight lending scheme that charges a premium interest rate, useless.
Second, we don’t think it is an appropriate time to launch a third LTRO as banks are still stuck with the first two repayments. Moreover, we saw previously that the LTRO has a positive impact on the Euro in the long-term. Liquidity will continue to drive sovereign yields lower and will tend to push the single currency at higher levels even though the Euro hasn’t been reacting to tightening spreads between periphery/core countries since Draghi’s press conference. Since July 2012, the 3-year spread Germany-Spain has tightened drastically and was one of main drivers of the Euro’s strength.
The third option is either a public or a private QE. A private quantitative easing would involve the purchases of private sectors assets, which could include asset-backed securities or bank bonds; rather than a public QE will include government bonds purchases (sovereign, ESM…). To me, these two options sound too much like a ‘whatever it takes to counter a strong Euro’, and we will repeat ourself by saying that ‘kill the Euro’ is not the core objective at the next meeting.
Quick analysis on EURUSD:
The pair found support slightly above 1.3580 and saw some bounce in Asia due to some short covering and saw technical ‘bull’ rebound after the RSI indicator was showing us an oversold signal. The resistance on the topside stands at 1.3641 (200-day SMA in blue), where we will start to see offers if the Euro continues to recover. The trend still looks a bit bearish at the moment, with 1.3520/40 as the next support area.