Draghi Says Little, Door Still Open for More

The shaving of 2017 and 2018 growth forecasts, recognition of continued
downside risks did not prompt the ECB to adjust monetary policy. 
 Rates were left unchanged, as widely expected.  
The ECB also refrained from extending the asset purchases.  This is somewhat disappointing.  It was
the only action that investors were discussing as a possibility.  
 Bond yields appear to be backing up in response.  
Many will suggest that the downgrade of the growth outlook is the
most important takeaway from the ECB’s press conference.  
e wonder whether, in the medium and longer terms, the
announcement that appropriate Eurosystem committees have been instructed to
evaluate the stimulus options is more important than the small tweaks in economic
forecasts.  This seems to be in
preparation of additional steps that may be necessary if the asset purchases are indeed extended. 
If the asset
purchases are extended, there may be a
need to change from the current decision-making principle that is based on the capital key.  
the capital key will be included in the
review, it may be resilient because of the precedent that abandoning it would
entail.  There are other steps that can
be taken to free-up more assets that can be bought in the program.  
Draghi pointed
out several times that the forecasts for inflation to rebound to 1.2% next year
and 1.6% in 2018 are predicated on
continued accommodative monetary policy.
  Although he said that there was no
discussion of extending the asset buying past March 2017, he explicitly cited
it as a possibility.  
Draghi appeared to
be taking a page from the footballers by going on the offense as reporters’ questions put him on the defense
.  He vigorously defended the combination
of orthodox and unorthodox policies, claiming they are effective.  The transmission
mechanism which had previously been a challenge is now working well, he judged, and fragmentation has been reduced. This
is why no new policies, including extending the asset purchases, were announced:
 They are not needed now.  Economic and monetary developments are
moving in the desired direction.  
Draghi was not
very sympathetic to claims that ECB policies were squeezing banks.
  He noted the important support that
the ECB has provided for the sector.  He
briefly hinted at the need for many European banks to change their business
models.  He suggested that all bank problems cannot be laid at the ECB’s door.  
To those who
say that ECB monetary policy is exhausted, Draghi reiterated that the ECB has
the will, capacity, and ability to do
more within its mandate. 
 At the same time, he clearly
recognized that monetary policy cannot do everything.  He pointed to the
G20 statement that recognized that
countries should not rely exclusively on monetary policy.  
Countries in
EMU who have fiscal space should use it.
  Germany has fiscal space. Over
the past week, Germany has reported soft PMI figures and, yesterday, an
unexpectedly poor industrial output.
Ironically, it may take an economic downturn in Germany to get the government
to loosen its purse strings.  
When everything is said and done, more was said than
 The Eurosystem committees will provide an evaluation of measures, while the ECB’s staff shaved next year’s
growth and inflation projections. There is no date provided for the
committees’ report, but it seems clear it
must be delivered before the current
buying program is to end (March 2017).  Indeed, a decision must be made
somewhat before then.  That is still six months away.  Although we
recognized that the ECB could have announced an extension of its program today,
we also appreciate that officials typically do not make a decision until they

After hovering
around $1.1250 since Monday afternoon, the euro was
bid to almost $1.1330. The high the euro reached just before the Jackson Hole optimism was $1.1340. 
  Momentum appears to be stalling as the European
session winds down.  On the downside, $1.1275 was the low the euro reached
since the decision was announced.
 With the two-year interest rate differential sitting near three-week
lows, and a soft US retail sales report expected in the middle of next week, a
break of $1.1250 could be significant.   Separately, note that the Dollar
Index, for which the euro is the largest component, has tested an uptrend line
drawn off the May, June and August lows.  It came in today near 94.45.
 The Dollar Index came within a tick of it and appears stabilizing with
the help of some short-covering by intraday participants. 


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