ECB Comments Gives EUR/USD Traders a Roller Coaster Ride

10/09/2009 12:01 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

The European Central Bank interest rate decision has triggered a tremendous amount of volatility in the EUR/USD. Initially, the currency pair raced to a high of 1.48 as the optimistic comments from ECB president Trichet and lack of new concerns on the euro reinforced the recovery story. However, just as quickly as it rallied, the EUR/USD gave back all of its gains in a move that is characteristic of the confusion in interpreting the ECB's stance.

Trichet's Comments on the Euro

In general, ECB president Trichet's tone was relatively upbeat, which should be positive for the euro because it suggests that he may be much closer to implementing an exit strategy than the Federal Reserve. However, he also repeated his previous comments on the euro and US dollar, which was enough to turn the currency pair around. More specifically, Trichet reiterated that excess volatility and disorderly movements in exchange rates are adverse for the global economy, and with that in mind, the US' strong dollar policy is extremely important in present circumstances.

If the ECB is growing more uncomfortable with the weakness of the US dollar and the strength of the euro, they are certainly not showing it. In our opinion, the fact that Trichet failed to say anything new about the euro is a good thing because it suggests that they do not feel an urgency to step up their degree of verbal intervention. In the words of Trichet "If we have anything to say on intervention, we will." As for the euro overtaking the dollar as a reserve currency, Trichet said the ECB does not actively promote the use of the euro on a global level. These comments are clearly due to their increased optimism about the outlook for the euro zone economy.

Trichet's Comments on the Economy and Inflation

According to ECB President Trichet, there are signs of stabilization in the euro zone and global economy. Everyone is finally coming out of freefall mode, which is a vote of confidence for the recovery story. Going forward, Trichet expects the economy to benefit from a recovery in exports and stimulus measures. The unemployment rate is still expected to rise, but the labor market could deteriorate less than anticipated. The primary risks are oil prices and protectionism. A bumpy road is expected to be ahead for the economy, and therefore, the recovery will be gradual. As for inflation, price pressures are expected to turn positive in the coming months, but it will remain subdued. With inflation expectations firmly anchored, the ECB is not losing sleep over potential price pressures. However, they are a tad worried by the weakness in loan growth. The second of the three one-year tenders was met with lackluster demand, but Trichet believes that this is because banks had cash already.

Trichet's Comments on Exit Strategies

The ECB is also not in a rush to implement an exit strategy. Trichet said that monetary stimulus is providing strong support for the economy and their unconventional measures will be unwound in a timely fashion when the economy improves. However there is an increasingly strong need for fiscal action and he believes that governments should design their own exit strategies that are in line with the EU pact.

For the Time Being, Interest Rates Remain Appropriate

Unlike the Fed, speculation that the ECB could add a spread to the one-year tender in December puts the central bank closer to tightening monetary policy, which is what traders should remember when they are considering the long-term outlook for the EUR/USD.

By Kathy Lien, Director of Currency Research at GFTForex.com

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