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ECB Holds Policy, Launches Review

Karl Schamotta January 23, 2020

In its latest decision, the European Central Bank kept its policy settings unchanged – but began a navel-gazing exercise that could have profound implications for markets in the long run. 

As expected, the Governing Council held the main refinancing rate at 0%, the deposit rate at -0.5%, and monthly asset purchases at 20 billion euros for an open-ended period. Forward guidance also remained substantively unchanged,  with rates set to remain at present or lower levels until the inflation outlook has “robustly” converged with the central bank’s target, and quantitative easing running “for as long as necessary.”

Instead, the central bank launched its first strategic review since 2003. Details on the scope and timetable won’t be released until after President Christine Lagarde’s press conference is finished, but reports have suggested that one assessment will be conducted on the institution’s price-targeting regime and another on longer-term issues like communication, financial stability and climate change.

This move – likely designed to address worries about increasing politicization – will focus market attention on the bank’s inflation-boosting bona fides. Negative rates and more than 2.6 trillion in asset purchases have failed to noticeably boost price growth toward the institution’s goal – and an (unlikely) shift in mandate could result in a change in tack that impacts the broader economy.

Lacking a catalyst, the euro traded sideways after the statement release, continuing to take direction from global dynamics.

With 17 dead, more than 570 infected, and three cities containing nearly 20 million people under lockdown, the ongoing coronavirus outbreak in China is beginning to impact financial markets globally, generating losses on the major Asian bourses and putting oil prices under pressure. The yuan has reversed much of its gains over the last month, the greenback is seeing safe-haven buying, and commodity-sensitive units like the Canadian dollar are facing stiff headwinds.

Of course, if prior episodes of contagion are any guide this move should be short-lived, with little lasting effect on foreign exchange markets. If selling intensifies in Asia, the export-led European economy could find itself on the firing line – but unwinding in euro-funded emerging market carry trades may limit the toll taken on the currency itself.

Record-low volatility levels look set to persist a little while longer…

Karl Schamotta
Chief Market Strategist

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