The ECB surprisingly cut its key rate to a record low of 0.25% as Q3 growth trended lower and deflation concerns rose
-Annual Eurozone inflation unexpectedly fell to 0.7% in October (1.1% in September)
-Monthly prices fell in 11 of 17 countries
Low inflation is not yet a problem but sustained deflation could depress demand and growth
-Fall in wages and prices may be temporary as they result from economic adjustment
-Sustained deflation, however, would lead to a vicious cycle of deeply depressed demand
ECB currently on hold with easing bias. Rate cut indirectly raises chance of unconventional policy
-Expect inflation to pick up to 1.4% in 2014 and only see further easing if conditions deteriorate
-If needed, the most likely next step would be further LTRO as a shift to negative deposit rates would be politically challenging
It has long been a saying at Fullermoney that no country wants a strong currency but some need a weak currency more than others. The ECB is contemplating a negative deposit rate as a way of stimulating lending in the region's banking sector, while the OECD is calling on it to adopt quantitative easing. The net result is that the ECB is more likely to ease than tighten.
On the other hand, the Fed is presented with an improving economy, recovering housing and financial assets that continue to rally. The logical question is whether they are willing to risk creating a mania in financial assets by leaving excess liquidity in the system for longer than it is strictly needed?
The divergence in policy stances between the Fed and the ECB and the effect this is having on sentiment is having an effect on the outlook for their respective currencies.
The Deutsche Bank Trade Weighted Euro Index rebounded sharply in the six months from July 2012 before pausing this year, mostly below 130. It posted a downside weekly key reversal in October and a downside key day reversal yesterday suggesting more than temporary supply dominance in the region of 130. A sustained move above that level would be required to question the medium-term progression of lower rally highs and overall supply dominance.
The Dollar Index has been trading in a volatile range, between 79 and 85, for nearly two years and is currently rallying from the lower boundary. From a medium-term perspective it is in the middle of a lengthy base formation.Back to top