Market Overview

17 July 2020

Europe Is Stomaching the ECB Approach and Waiting for a Recovery Fund Deal

The European Central Bank (ECB) kept its ultra-loose policy on Thursday after taking unprecedented measures over the past several months to fight the recession. At a post-policy meeting press conference, the ECB President Christine Lagarde commented that incoming information "signals a resumption of Euro area economic activity, although the level of activity remains well below the levels prevailing before the coronavirus pandemic, and the outlook remains highly uncertain".

Indeed, the composite Eurozone ZEW Economic Sentiment for July showed a five-year record of 59.6 points, so it's been growing for four months in a row. Industrial production data for May published this week marked a 12.4% growth month on month after the catastrophic 11.9% fall in March plus a 18.2% additional drop in April. But, even now it is still more than 20% down year-on-year, while European new car sales were 24.1% down in June vs the same period of 2019, statistics from the European Auto Industry Association (ACEA) showed. Although in Europe, unlike the United States, there are no remarkable infectious outbreaks the timing of the recovery of the Old World economy remains very uncertain.

Mrs Lagarde also admitted that uncertainty over the scale of the rebound remains high, the balance of risks remains on the downside while "both high-frequency and survey indicators bottomed out in April and showed a significant, though uneven and partial, recovery in May and June alongside with the ongoing containment of the virus and the associated easing of the lockdown measures". Actual and expected job and income losses and the "exceptionally elevated uncertainty about the evolution of the pandemic and the economic outlook" continue to weigh on consumer spending and on business investments.

Thus, as she emphasised, the ECB's ample monetary stimulus remains necessary to safeguard the recovery process, but "we have slowed down a little bit the pace of purchases". "Unless there would be significant upside surprise, our baseline remains we will use the entire envelope of the pandemic emergency purchase programme (PEPP)," she added. Under the PEPP plan, the ECB is buying billions of Euros worth of corporate and government debt in order to supply the EU financial system and the companies with a sufficient money flow, while keeping borrowing costs low at the same time. The government bond yields are still higher in most European jurisdictions now than they were before the pandemic, and the spreads for high-yield corporate bonds declined. Mrs Lagarde commented that the ECB made "front-loaded" PEPP purchases for over 360 billion Euros just in the first couple of months and that these were the figures for the end of June. "It is effective, it is adequate and it is working. We have not discussed altering the PEPP programme. We do not see a need to revisit," Christine Lagarde said.

"We really spent a good deal of time looking at the economic circumstances ... And really, seeing the developments in the economy, we really felt that we were in a good place at the moment," she said, summarising  the discussion. Probably, the ECB feels no urgency to do even more than it is doing already or at least no need to do it faster. Overall, European markets rather welcomed this approach, and in any case were happy that it is clearly not about potential ECB's buying "junk bonds" in such conditions. The major European stock indexes rose slightly before Thursday's close, and on Friday were just a little upset in the absence of new incentives and because of the arrhythmic and weak pulse of the U.S. index futures. The single European currency rose and tested the 1.1440 resistance zone again on Thursday against the U.S. Dollar. However, a partial safe-haven demand for the Greenback pushed EUR/USD down to 1.1370, but the pair again recovered to the level above 1.1420 by Friday noon.

The continued upside pressure in EUR/USD may be attributed to investors' awareness of the fact that the Federal Reserve's monetary emission has diluted the Dollar money supply to a much more rarefied state than the ECB did with the Euro. The EUR/USD may have a potential to not only surpass the 1.15 mark, but also pull up higher to the 1.18 or even the 1.20 levels. This doesn't look like an impossible scenario, although it seemed to be an absolutely unthinkable idea in mid-March, when EUR/USD tried to test the strength of the supports below 1.07.

For this weekend, one more intermediary step for the future of the political agreement on the European Recovery Fund is still feasible, although the final approval may need another round of negotiating. It may involve lots of "horse-trading" between country leaders as they start their meeting this Friday. So, the currency markets and stocks may be quiet as they wait for at least some signs of further progress on the contested budget points and fund distribution principles. So, during the rest of the European evening markets could be as quiet as a mouse. Of course, if the American playful kittens are not going to do a bad turn.


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