ECB’s accidental euro devaluation: James Saft

October 22, 2015

Oct 22 (Reuters) – For a central bank not trying to drive
down the euro, the European Central Bank is doing a pretty poor
job.

That’s only fair, in that the Federal Reserve is doing a
flat-out lousy job of normalizing interest rates for a central
bank which says that that is its aim.

The euro dropped sharply after Mario Draghi and the ECB
indicated that more QE and even lower interest rates could be on
the way as early as late this year.

The euro fell more than two cents against the dollar
to $1.11, taking it back to levels it saw in August, when
markets actually believed the Fed would move in 2015.

The euro is down more than 8 percent against the dollar
year-to-date, and has fallen by 12 percent over the past year.

Nothing to do with Mario, of course.

“I’ve said it many times, for us the exchange rate is not a
policy target,” Draghi said at the press conference following
the ECB’s decision to stand pat.

“It’s important for price stability, for growth, but it’s
not a policy target. The movements in the exchange rate (over)
three years were the outcome of diverging monetary policy cycles
as well as divergent economic recovery paths between major
jurisdictions. They were not intended, it was not an action
geared to cause these exchange rate movements. They were the
outcome.”

In other words, it’s not that I meant to stab your hand,
it’s just that it was right over my steak.

Economists weren’t buying this either:

“They do want actually to drive the euro exchange rate
lower, even though history (above all the interventions of the
1980s and 1990s) shows this is totally ineffective, in fact all
too often a policy which backfires,” Marc Ostwald of ADM
Investor Services wrote in a note to clients, going so far as to
label Draghi’s disavowal “an outright lie.”

If we judge intentions by outcomes then we can say two
things about the ECB’s performance today: they aren’t being
straight about their intentions, but they are, for the time
being, successful.

Not only did the euro fall, but so did bond yields, reacting
to what investors took to be indications that not only will QE
be extended, expanded or tinkered with in December but that we
may also see an even lower deposit rate.

When the ECB took the deposit rate to -0.20 percent last
year, Draghi, you may remember, said no additional rate cut was
possible.

NICE POLICIES, SHAME ABOUT THOSE RESULTS

So while it is nice to see policy-makers pushing the
boundaries of the possible, the main issues facing the ECB, and
for that matter the Bank of Japan and Federal Reserve, is the
striking lack of strong evidence that these policies work well.

The Fed itself, though understandably keen to get interest
rates up off of the zero bound before the business cycle, as it
must, turns south, has thus far been unable to turn the trick.
While September was once thought a done deal for a hike, March
is now only seen as a 50/50 chance.

There simply doesn’t seem to be much evidence that QE and
zero rates have done much to drive inflation higher.

Today’s market response was driven in part by the faith
traders have that QE is effective, if not in the real economy,
then at least in financial markets, particularly currencies.

Kit Juckes, strategist at Societe Generale in London,
disagrees: “I am doubtful that increased conventional QE
(bond-buying) by the ECB or the BOJ will weaken the yen or the
euro significantly further from their recent lows. Indeed, I’m
not sure how much of the weakness in either currency to date can
really be attributed to QE in the first place,” he writes.

While QE in the U.S. may have hurt the dollar by driving
flows to emerging markets, which in turn drove emerging market
central banks to both intervene and to buy Treasuries, elsewhere
other factors came into play. The ECB and BOJ achieved what
devaluation they have by, in Japan a switch to overseas equities
among savers, and in Europe the introduction of negative rates.

Still, the market salivates and sells euros when Draghi says
QE. If he doesn’t follow up with the meat of a further reduction
in interest rates, the response may fail next time.

As always, give more weight to what central banks do than to
what they say.
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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