ECB Highlights Cyclical Monetary Policy Differences with the Federal Reserve

Mario Draghi highlighted that ECB's monetary policy conditions have decoupled from the US with the introduction of the negative deposit

Mario Draghi, President of the ECB
Mario Draghi, President of the ECB

Few people expected an eventful press conference by the European Central Bank (ECB) this past month, however President Mario Draghi thought differently. In a very persistent, or even insistent way he outlined on numerous occasions during the hour-long event, that the conditions on the foreign exchange market have changed for good.

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Mr. Draghi stated that the ECB has decoupled its monetary conditions with the United States with the introduction of the negative deposit rate, and the divergence is here to stay for a while.

While the short-term flows of the euro to the US dollar did not immedeately react to his speech materially with daily ranges holding as of writing, the President of the ECB highlighted,”Fundamentals for a weaker exchange rate are now much better than two-three months ago.” This is a point previously touched upon by Forex Magnates, and we have seen the euro declining ever since, after the infamous mention by Mr. Draghi of negative interest rates.

In his Q&A session, the President of the ECB mentioned, “Markets have perceived that the monetary policies of the United States, the United Kingdom and the Euro Zone  are going to stay divergent for a long time,” highlighting that the easing effort will last “much longer time in Europe than in the rest of major economies.”

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What Does This Mean for FX Volatility?

So far we have seen the euro declining rather slowly in tandem with the whole market, however another point mentioned by Mr. Draghi could come to the front and change that – geopolitical risks. He stated, “Heightened geopolitical risks and risks surrounding emerging markets economies,” could result in weaker global demand for European products and ongoing weaker domestic demand due to balance sheet adjustments in the private and public sectors can create additional downside risks.

While for now the euro has lost only about 4 cents to the US dollar since the first mention of negative deposit rates by the ECB, going forward volatility will be mostly dependent on additional market jitters. Mr. Draghi mentioned that a sanction-counter-sanction duel which is forming between the EU and Russia is a situation which could in the end require additional monetary policy measures, bearing in mind that the risks to energy price developments are also a component of current global geopolitical issues.

Mr. Draghi has clearly and repeatedly communicated to the market that the ECB desires a weaker exchnage rate of the euro. The single currency’s strength has been dampening economic activity in countries which have not engaged in sufficient structural reform and the central bank continues to aim to take pressure off governments. The only question is how far will the euro go this time around and how fast?

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