Draghi condemns the euro to a downward spiral by stating that further expansionary measures are very likely in December

Weekly Analysis of the Foreign Exchange Market

Last week, in a special report following the European Central Bank meeting, we highlighted the importance of this meeting for the markets, after Draghi indicated possible additional measures in December.

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Specifically, the ECB President suggested that the December meeting would most likely serve to expand the current easing program, both in size and duration. The euro reacted by falling sharply against the dollar after the press conference and continued to do so until the close of the US market on Friday.

 

The common currency dragged down most European currencies, which ended the week trading 2,5-3% lower against the dollar. As for the euro, we expect it to resume its downward trend against its major counterparts.

 

EUR

 

We have long been pointing to the need for Eurozone monetary authorities to act, given the context of very weak growth and negative inflation. On Thursday, as we expected, the ECB finally reacted to this and other downside risks at its October monetary policy meeting, announcing that, with a high probability, further easing measures could be taken at the December meeting, not only related to extending the current program, but also possible further cuts in deposit rates.

 

It's curious that the ECB's pessimism came in a week where the economic data released was moderately positive. The composite PMI rose slightly in October, and lending facilities appear to be increasing, indicating that the current quantitative easing program is beginning to have an impact on the real economy. However, a sustained rally for the euro against other currencies is unlikely, given the ECB's expectations of launching further stimulus measures.

 

GBP

 

Last week we saw a surprise in the UK retail sales figures, which rose sharply in September. Overall sales increased by 1,9% for the month, while annual growth is in the 6-7% range, suggesting that falling unemployment and wage growth may finally be translating into increased consumer confidence and, consequently, higher spending. Although retail sales are highly volatile and prone to revisions, last week's data supported our view of healthy growth of 2-3% and a possible interest rate hike by the Bank of England in the second quarter of 2016, sooner than the market expects.

 

USD

 

Last week, very strong housing market data was released. Both new home construction and some indicators of new housing permits increased sharply in the third quarter of 2015. The outlook for US GDP growth appears to be clearing for the third quarter, as domestic demand is growing at a very healthy rate of 3% annualized. We expect that this, combined with the anticipated rebound in job creation and wage growth, will provide sufficient support for a majority of FOMC members to vote in favor of a first rate hike at the December meeting.

 

Source: Ebury