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Draghi’s bazooka misfires

Yesterday’s initial reaction to the ECB’s surprise policy measures were as you would have expected, with equities rallying sharply and the euro falling, but they were never the bazooka that some people were suggesting they were.

The measures were certainly innovative and a €20bn expansion of QE to include investment grade non-financial corporate bonds was certainly unexpected, but it was also an admission that the ECB was running out of available assets to buy.

The initial move higher in the DAX and fall in the euro was right out of the central bankers playbook, but it was the admission by Mr Draghi during the press conference that policymakers were concerned about pushing rates too low, due to concerns about the effects on bank balance sheets that prompted a sharp turnaround in the euro and unwound the initial gains in equity markets.

This tacit admission that the bank appeared constrained by a lower bound for rates put a floor under market expectations for further rate cuts, and while Mr Draghi didn’t rule out further rate reductions, and said rates were likely to remain low for some time, it seemed quite apparent that they were well down the list of possible next moves.

It appears that it was this realisation that saw the euro reverse course sharply, despite an aggressive downgrading of this year’s inflation forecast to 0.1% from 1%.

The ECB’s measures to mitigate the effects of negative rates on banks were certainly unique with the announcement of four new quarterly 4 year TLTRO’s loan schemes to help boost new lending.

As a means to mitigating negative rates on banks’ balance sheets they will offset the effect by paying the banks to lend money to the real economy, at a rate between 0% and -0.4%, with the rate being paid tied to the amount of money lent out. The more lent out the higher the rate the ECB will pay the lending bank.

With these measures it appears that the ECB is more concerned about the creation of credit and the banking system than the current value of the exchange rate, however I don’t imagine that the ECB President expected to see the euro finish the day sharply higher and European stocks lower.

The fall in stock markets yesterday also wasn’t helped by a sharp fall in oil prices on reports that the meeting between OPEC and non OPEC members in Moscow later this month had been cancelled due to the apparent unwillingness of Iran to freeze its output, until it was back to pre-sanction levels, of around 4m barrels a day. This drop proved to be rather short-lived as a combination of a weaker US dollar and falling production output helped put a floor under prices, despite still elevated inventory levels.

As a result of yesterday’s disappointment, European equity markets could well finish the week lower for the first time since the 11th February lows, though we look set to open higher this morning as a result of US markets pulling off their lows, and a firmer Asia session.

The only data of note today is the latest UK January trade balance numbers which is expected to widen slightly to £3bn from £2.7bn in December, though we can also expect investors to be eyeing this weekend’s Chinese industrial production and retail sales data for February.

Given yesterday’s ECB action could we see further easing from Chinese policymakers if this weekend’s numbers disappoint as much as this week’s trade numbers did.

EURUSD – the break above the 200 day MA at 1.1050 has seen the euro push higher and as such now becomes key support. We also got the subsequent move to 1.1200 with the next resistance at 1.1380, February highs. Only below 1.1030 argues for a move towards 1.0800, with a break targeting 1.0600.

GBPUSD – after an initial spike lower to 1.4118 the pound rebounded strongly and made a 2 week high above 1.4300. While above 1.4100 the bias remains towards the upside and the potential for further gains towards 1.4400. A fall below 1.4080 retargets the lows at 1.3835.

EURGBP – despite a dip below the 0.7690 support the euro reversed sharply higher in a classic bear trap. It has currently run into resistance at 0.7860, but if this breaks could well revisit the 0.7930 area.

USDJPY – still side-lined between support at 111.00 and resistance at 114.90 we need to see a break one way or the other for clues as to the next move. The bias remains towards the downside towards 106.00 while resistance at 114.80 remains intact. Above 115.00 argues a short term base is in place.

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