The ECB: another tale of two central banks
Is the ECB on the same planet as the BOE and the Fed? That is a valid question to ask after the ECB meeting on Thursday. There has been growing hawkish rumblings at the BOE in recent weeks, and there is pressure from some corners in the US for the Fed to react to persistently strong inflation readings, however, Christine Lagarde, President of the ECB, said that the outlook for inflation in the currency bloc was “subdued” even though growth was likely to remain strong into the third quarter. Lagarde sounded concerned about the spread of the Delta variant across Europe, however, markets have already had their stutter on the back of Delta fears, and Eurozone indices are higher today while German bond yields are down a touch.
ECB in uber dovish mode
Overall, today’s ECB meeting has not shifted the dial when it comes to expectations around ECB policy in the long term even though this was the first meeting that the ECB used its new policy framework. It now has a 2% inflation target, and it will no longer be targeting price growth below this level. Like the Fed, it has said that it will tolerate periods of higher inflation. This new policy framework was reflected in the ECB’s revised forward guidance for interest rates. The ECB said that it expects interest rates at their present or lower levels until it sees inflation reaching its 2% target rate.
By shifting its inflation target to 2%, from 2% to just below, the ECB is, theoretically, lowering the bar to being able to raise interest rates. However, the current mood at the ECB remains uber dovish, thus the ECB also said that it expects interest rates to remain at their present or lower levels “for the rest of the projection horizon”. The ECB also said that it expects a transitory period of higher inflation, but that underlying inflation will only be “sufficiently advanced to be consistent with inflation stabilising at 2% over the medium term”. This is effectively a dovish shift from the ECB, and it is a promise to be more accommodative for a longer period of time. Thus, this policy meeting suggests that the ECB’s latest stance will see it fall behind the BOE and the Fed when it comes to the outlook for interest rates in the next two years.
ECB removes any hint of doubt from its policy projections
This move from the ECB makes its policy clearer and highlights that its bar to tightening remains extremely high, even with raising its inflation target. The ECB now expects Eurozone inflation of 1.9% this year, before falling to 1.5% and 1.4% in 2022 and 2023. The ECB promised to continue its bond purchases until March 2022, however, there is now speculation about what the ECB could replace this with, especially if price pressures start to fade in the coming months.
With projections for price growth as weak as this, the only way to ensure that the Eurozone economy attempts to reach the ECB’s inflation target is to guarantee that accommodative monetary policy will be in play for the long term. On the back of today’s meeting, it could be many years before we see the ECB tightening policy. The market implication of today’s meeting is supportive in the short term for stocks, as long as the Delta variant does not get out of hand, and it is likely to continue to weigh on the euro, which has been coming under pressure in recent months.
FX: the impact on the euro
EUR/USD had a fairly neutral day on the back of the ECB meeting, as the euro has been weakening since the end of May. EUR/USD is still below the $1.18 handle, major support comes in at $1.1710 – the low from the end of March. The market is likely to target this level, however, the question is, will that be where the sell-off in the euro ends, or will there be further downside? The same could be said for EUR/GBP, which has had a sharper fall in the last 6-months and could see more downside after being range-bound for most of the summer. The problem for traders right now is that volatility has drained from the FX market, and the prospect of an uber dovish ECB for the long term is likely to see volatility drain further. Thus, even if we do see more downside for the euro, we expect it to drop in small, even steps, with 0.8450 – the low from April, now in view for EUR/GBP.
Where to find volatility right now
Right now, volatility hunters are able to find more interesting opportunities on the back of Q2 earnings season, with Unilever falling more than 5.5% on Thursday. It was the biggest loser on the FTSE 100 after warning that rising commodity prices could hurt its full year operating margin. The market, which tends to be forward-looking, ignored the better-than-expected revenue for Q2 after strong sales of ice cream and tea. We expect this to be a wide-spread problem with the consumer goods sector suffering from high inflation in the coming months.
Elsewhere, 3i, the private equity group, had a strong start to the year, after it reported better than expected sales in Q2, and said that its private equity portfolio generated good profits, with its top 20 assets all experiencing strong upward momentum. These strong results saw its share price rise more than 3%, although CEO Simon Burrows continued to focus on Action retail’s recovery from the pandemic, when the outlook for the UK remains uncertain on the back of the rising number of corona cases.
Does Netflix deserve a break?
Netflix’ share price meanwhile, has not yet been able to reverse the sharp decline after its results earlier this week. It reported earnings that missed the target, however, paid net subscribers were stronger than expected even though subscriber growth has slumped compared to a year ago. Netflix’s share price has fallen some 6% on the back of this news, however, the fact that it is adding video games to its content library, which could boost subscriber growth in the future, and the fact that revenues remain strong at the streaming giant, with $7.34bn revenue generated last quarter, could see a recovery rally in the coming days. In the short term, $510.00, is strong support, and could act as a springboard back to the pre-earnings level of $535.