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Nothing to ECB Here, Move Along

Karl Schamotta July 26, 2018

In a widely-telegraphed decision, the European Central Bank kept interest rates on hold, and policymakers reiterated a conditional commitment to lower asset purchases to zero by year end. The Governing Council said that it “expects the key ECB interest rates to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2 percent over the medium term” – aligning with the message originally communicated at the Bank’s June update.

The Bank also repeated earlier language, saying, “after September 2018, subject to incoming data confirming the Governing Council’s medium-term inflation outlook, the monthly pace of the net asset purchases will be reduced to €15 billion until the end of December 2018 and that net purchases will then end”.

In the press conference, President Mario Draghi (wearing a purple tie) said that “uncertainty around the inflation outlook is receding”, suggesting that price growth is expected to pick up toward the end of the year.

The common currency remains well-supported after a meeting between Donald Trump and European Commission President Jean-Claude Juncker, in which the two agreed to a de-escalation in trade tensions. According to published reports, the Europeans will consider buying American soybeans and liquified natural gas (LNG), and will enter into negotiations aimed at reducing tariffs on non-automotive industrial products. In return, Trump agreed to refrain from imposing car tariffs.

The reality, of course, is much more messy.

The European Commission ostensibly manages trade policy on behalf of the European Union’s member countries, but its decisions must ultimately survive ratification by 38 national and regional parliaments. Both the Walloon assembly in Namur and the French community in Brussels temporarily vetoed the Comprehensive Economic and Trade Agreement, and countries like Austria and Italy have dragged their heels on ratification.

Tariffs are not currently applied against soybeans, and the Commission has very little influence over buying decisions. With China currently shifting its purchases to Brazil, European buyers were already likely to shift to American producers, but the economic bloc simply doesn’t have enough demand to offset the Asian country’s purchases – China’s soybean imports last year were roughly six times larger.

European LNG imports are increasing, but again, shipments from the United States will be dictated by demand and supply conditions – not through the trade policy channel.

In short, Juncker seems to have sold President a bridge – and (beyond proving that political leverage works on Trump) if you believe that this agreement brings the ‘trade wars’ narrative to an end, we have one to sell as well…

Bottom Line: After a clear communication of intentions in June, market expectations were low going into today’s European Central Bank meeting – indeed, traders were arguably more focused on Mario Draghi’s tie colour than on his comments. Instead, with exports brought forward ahead of tariff deadlines and major uncertainties clouding the activity outlook, tomorrow’s second-quarter gross domestic product number in the United States is likely to introduce exchange rate volatility. Markets remain heavily long-dollar, and modestly short-euro – suggesting that positions could rationalize somewhat in the coming weeks as the trade war narrative fades and economies outside the United States begin to catch up.

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