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Euro Stagnation and QE Speculation

By Patrick Higgins  |  18/07/2017 07:53
The Euro continues to stagnate as the ECB remains indecisive on QE policy.
 
The European Central Bank (ECB) is reluctant to place a firm end-date on its € 2.3 trillion QE programme, instead opting to remain flexible should the health of the Euro/Eurozone takes a turn for the worse.  Without specifying when bond-buying levels will be negligible, it is clear that the message being delivered is one of no strict scheduling, being entirely subject to sustained growth in GDP and national wages.
 
Euro appreciation against the USD continues to move ahead (albeit at a cautious pace), alongside higher levels Eurozone growth.  This appreciation comes after many years of EUR/USD depreciation, due to US economic recovery while the Eurozone found itself deeply entrenched in a debt crisis.  However, many investors do not expect the Euro to reach $1.20 this year, due to ECB unease.  The median estimate was put at $1.13 by December, a complete turnaround from just two weeks ago when the Euro reached $1.15 against the dollar after ECB President Mario Draghi gave a speech indicating continued interest in small changes of its QE programme.  The ECB, focused on reaching its Eurozone-wide goal of a 2% inflation rate, cannot afford for the Euro to increase too much in value too soon.
 
As our analysts discussed in the previous month, the ECB and Mr Draghi still seem to be open to some alterations in QE, such as the reduction of easing biases.  However, the ECB is still committed to purchasing 60 billion Euros worth of Eurozone bonds through the end of the year.  The question is, what changes will be seen in 2018?
 
Many expect answers to be delivered cryptically at the ECB's general meeting on September 7th.  Any tapering, or QE reduction, will only commence following the conclusion of December and into 2018.  The level of any tapering, while bound to happen, is unknown as of yet.  The ECB seems to be taking its initiative for no planned end-date on QE from the Fed, which also was reluctant to provide conclusion forecasts.  However, the difference between the two are the approaches to tapering.  Once the Fed began tapering in December 2013, it reduced QE by $10 billion a month.  This amount was constant until the end of the programme in October 2014.  The ECB, which is responsible for the currency policies of 19 countries (unlike the FED, which covers just one), is much more reluctant to set pre-fixed QE easing amounts.  The ECB will have a tough time convincing markets that tapering flexibility is a good thing.  While it does provide wiggle-room for adjustments in Eurozone policy (arguably necessary for such a large financial bloc), undetermined QE reduction amounts per month will make investors jittery and could cause the Euro to go haywire.  While the Eurozone has seen sustained economic growth and declines in unemployment, inflation continues to be a source of irritation for the ECB.  Eurozone inflation is not projected to reach the ECB target of 2% until at least 2019, slowing wage growth immensely.
 
One of the most instrumental stories to look out for in the coming year will be German wage negotiations.  The health of the Eurozone's largest economy, and whether wages will rise accordingly, will be a huge indicator to the ECB on whether QE should be adjusted.  Relatedly, similarly to last December, the ECB may again cut QE spending by 25% but extend the time frame considerably.  Whatever the outcome, the ECB seems to be committed to QE flexibility.  Changes in bond buying can be expected, but the extent of such changes are, as yet, unclear.
 
The Euro today hangs in the red against the dollar, at $1.1463 (-0.03%), 3:31 PM BST
 

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