Is the ECB overreaching?

Is the ECB overreaching?

Good morning and welcome to today’s foreign exchange market commentary on Monday, the 10th of September.

When the European Central Bank announced its decision to intervene in the secondary bond markets to buy govt. debts of stricken countries only when they agree to tough, externally monitored reform programs on Sep 6, markets went ballistic.

The ECB has grown in stature after each crisis that hit the currency union, often emerging as the only backstop between the euro and the cesspit. The proposed new banking supervisor will be a subsidiary of the central bank and the ECB it already is part of the group that monitors and enforces compliance of aid conditions by debtor countries.

The mandate of the ECB was to set interest rates and maintaining price stability. Is it becoming too political now?

On the face of it, the ECB is providing important leadership that the Eurozone’s leaders failed at after struggling for more than two years with the worst debt crisis since World War II. While the reasons for the failure of the political class in demonstrating leadership are manifold, the ECB is mostly free from such handicaps. While politicians must seek approval from the electorate before committing taxpayer’s money, the ECB can, at least hypothetically, print unlimited money. Draghi is not accountable to any elected representative but the unelected Governing Council of the ECB.

Draghi is supposed to be apolitical, yet he’s present in every EU summit. Last December he dropped hints of fiscal compact in a casual manner. Coincidentally, EU leaders agreed to new treaties on balanced budget rules shortly thereafter. Benevolent Draghi subsequently injected EUR 1 trillion in the region’s banks with LTROs.

The ECB has stopped dropping subtle hints now and has become more vocal and articulate. It has now clearly spelled out conditions for receiving aid money; countries must agree to external monitoring before making a formal bailout request, and the region’s life boat fund-the EFSF and its successor the ESM should buy bonds from the primary market, subject to the German high court’s approval. In an article written for Die Zeit last month, Draghi said political union can develop hand-in-hand with economic, financial and fiscal union, adding accountability and power-sharing can move in parallel. Not too many central bankers have gone to such length before, articulating measures on political and economic reforms.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2504
GBP/US$ – 1.5986
GBP/CHF – 1.5128
GBP/CAN$ – 1.5649
GBP/AUS$ – 1.5448
GBP/ZAR – 13.0831
GBP/JPY – 125.16
GBP/HKD – 12.4014
GBP/NZD – 1.9731
GBP/SEK – 10.5982

EUR: The single currency capped the week on a high Friday, closing at 1.2820 against the greenback while it had opened below 1.2600 last week. The weaker than expected non-farm US payroll data was attributed to the dollar’s weakness as chances of another round of quantitative easing brightened. However, the euro is likely to push ahead further as markets await the German high court’s decision on constitutional validity of the European Stability Mechanism. The Netherlands are due to go to polls on the same day, i.e. Sep 12 and markets will hope a euro-friendly govt. comes to power. Also a Euro-group meeting is scheduled on Friday where Spanish and Italian bailout conditions are likely to be discussed. The GBP/EUR pair is trading around 1.2505.

USD: Stronger than expected UK manufacturing production and PPI data pushed the cable higher against the USD on Friday. UK production jumped 2.9 percent in July over the previous month, the biggest jump in 25 years. The GBP/USD pair surged to a high of 1.5988 on the back of manufacturing data and went on to clip the 1.6000 level after US non-Farm payrolls data fell short of forecasts. The cable rose to 1.6035 as NFP data of 96,000 against a consensus of 120,000 raised the prospect of further QE3. The FOMC meeting and US CPI data is due in the later half of the week and the dollar may weaken further against the pound. Cable opens above the 1.6000 level this morning as markets prepare for the German court ruling on the constitutionality of ESM on Wednesday.

Have a great weekend!

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