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17 Mar 2014
Flash: Draghi reveals a EUR/USD target - HSBC
FXStreet (Bali) - Following last week's comments by ECB President Mario Draghi, in view of David Bloom, Global Head of FX Research at HSBC, the ECB has hinted it will allow 1.40 as soft target and 1.45 as a hard target for EUR/USD, with the latter likely see the ECB action stepped up.
Key Quotes
"The ECB stepped up its rhetoric when the euro was about to breach 1.40. This is no freak of nature. This deliberate stance is because the ECB needs to stop a move to 1.45 and beyond that could cause it to miss its mandate. Draghi has admitted that the EUR is becoming "increasingly relevant" in the central bank's assessment of price stability, but also argues that the ECB does not target the exchange rate. However, this stance is slowly being unpicked especially as the move has been slow and volatility is not a factor. The secret is being revealed — the level matters. If the EUR continues to rise, it threatens their mandate and on this basis it's open season."
"The ECB's mandate is inflation close to, but below, 2%. The current staff forecasts suggest inflation will be back to 1.7% by Q4 16 — in line with the ECB's mandate. Hence the ECB is not worried about disinflation. Importantly this assumes an unchanged exchange rate, or around 1.36 on EUR-USD. Now the question is — what would the exchange rate have to move to make them worry about missing their inflation target? Draghi said each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points. Realistically, any exchange rate move would likely have to point to inflation being sub-1.5% for it to be worthy of action. So what exchange rate level would get inflation from their 1.7% forecast to below 1.5%? Using the ECB's ready reckoner, it would point to a pain threshold of 1.45. Most likely, the ECB recognises that were EUR to gain a foothold above 1.40, it could easily push on to 1.45. Better to draw the line at 1.40 than wait for 1.45."
Key Quotes
"The ECB stepped up its rhetoric when the euro was about to breach 1.40. This is no freak of nature. This deliberate stance is because the ECB needs to stop a move to 1.45 and beyond that could cause it to miss its mandate. Draghi has admitted that the EUR is becoming "increasingly relevant" in the central bank's assessment of price stability, but also argues that the ECB does not target the exchange rate. However, this stance is slowly being unpicked especially as the move has been slow and volatility is not a factor. The secret is being revealed — the level matters. If the EUR continues to rise, it threatens their mandate and on this basis it's open season."
"The ECB's mandate is inflation close to, but below, 2%. The current staff forecasts suggest inflation will be back to 1.7% by Q4 16 — in line with the ECB's mandate. Hence the ECB is not worried about disinflation. Importantly this assumes an unchanged exchange rate, or around 1.36 on EUR-USD. Now the question is — what would the exchange rate have to move to make them worry about missing their inflation target? Draghi said each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points. Realistically, any exchange rate move would likely have to point to inflation being sub-1.5% for it to be worthy of action. So what exchange rate level would get inflation from their 1.7% forecast to below 1.5%? Using the ECB's ready reckoner, it would point to a pain threshold of 1.45. Most likely, the ECB recognises that were EUR to gain a foothold above 1.40, it could easily push on to 1.45. Better to draw the line at 1.40 than wait for 1.45."