The opening of the PSPP triggered a new decline of the exchange rate. Two factors (negative rates and the prospect of a restrictive monetary policy cycle in the United States in the next two years) warn that the euro’s decline will not necessarily be limited to the opening weeks of the programme….
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– A lower exchange rate could justify a marginal upward revision of forecasts for the euro area, although weak industrial output data in January advise caution.
– Greece: some progress being made towards a constructive solution, although the clash with Germany is cause for concern.
– The opening of the PSPP at a brisk pace (9.8 billion in purchases in three days, according to Coeuré’s statements on Thursday) is causing sweeping turmoil on the markets: yields on German debt have now dropped to close to the -0.2% mark on the 2-4Y segment, are negative up to the seven-year maturity, and have in any case undergone dizzying declines on the longer end of the curve as well. The spreads paid by the other sovereign issuers have also decreased. Lastly, the euro’s decline on the currency markets has accelerated, and a low was hit on Thursday at 1.0494 dollars. The euro’s effective exchange rate has depreciated by around 5% since mid-February and by over 13% since mid-December.
– The temptation to project the trends recorded in the opening days of the programme to the entire duration of PSPP must be resisted: as the programme advances, the stabilisation of growth and inflation expectations at higher levels will prevail on the pressure exerted by flows, resulting in higher rates. This was also the case with QE in the United States. In Europe, some additional doubts linger due to the significant size of the programme, although markets are expected to stabilise before and at the beginning of the programme, rather than during its implementation. However, on the currency markets the combination of the potential increase in policy rates in the United States, and negative of zero interest rates on most of the European curve, call to mind the scenario seen in the 1999-2000 biennium, when the exchange rate against the dollar plummeted from 1.18 to 0.83, and rose back over parity only at the end of 2002. Although the movement of the exchange rate has already been very substantial, the unprecedented presence of negative rates could further impact it in the months ahead, more than suggested by forecasting models. Flows addressed to the stock markets, supported by improving earnings expectations, are unlikely to be of sufficient size to balance flight from bonds and from interbank deposits in euros. This introduces new upside risks to our growth and inflation scenario for the euro area. We have already stepped up our inflation forecasts to price in the sharper rebound of oil prices from January lows. As regards growth estimates, the revision will not necessarily be limited to 2015: the year has not got off to a good start for industrial output, and barring a sharp rebound in February, GDP growth in 1Q 2015 may fall short of the current forecast of 0.3% q/q.
– Another shadow looms over the euro, projected by Greece. The Tsipras government is struggling to find a productive negotiation strategy, mixing aggressive acts against Germany, considered to be its main opponent in Europe, with conciliatory declarations on its intention to respect the commitments made. Greece’s bargaining power is very low, also considering that every instance of exacerbation of the confrontation with international creditors fuels the flight of deposits from banks, of capitals, and tax evasion, pushing the government dangerously to the edge of a precipice. The good news from Athens this week is that technical consultations with the institutions have begun, and the Greek government has reached an agreement with the OECD to collaborate on structural reforms. Also, the ECB is keeping the financial system above water by means of small week-to-week extensions of the emergency liquidity assistance (ELA) supplied to Greek banks, in waiting to see whether the tranche of bailout funds will ultimately be unblocked.
Appendix
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