ECB’s “Do or Do Not” dilemma

ECB’s “Do or Do Not” dilemma

Good morning and welcome to today’s foreign exchange market commentary on Friday, the 7th of September.

Markets globally reacted emphatically to the ECB’s so-called Outright Monetary Transactions program or OMT yesterday. The European Central Bank has been torn between its duty as a lender of last resort and its aversion to funding governments. It has at last compromised with the former and reconciled with the latter with yesterday’s official OMT.

But markets can be unpredictable as witnessed in the past. Draghi’s much publicised pledge to protect the euro at any cost a few weeks back had a fleeting effect on the markets. Yesterday’s program on the other hand raises some serious questions. In Draghi’s own words, there was one vote of dissent in the Governing Council meeting, which was cast by the Bundesbank chief Jens Weidmann. How long can the ECB run the program successfully in the face of continuous opposition from its most powerful member?

The key question however is whether the Italians and the Spanish would be willing to seek help, particularly due to the strict conditions attached. OMT is useless unless they formally request for a bailout. If the mere announcement of ECB drives down short-term borrowing costs, governments would be less inclined to seek help, which seems ideal on the face of it. However, if the Bundebank’s argument is correct, then this also will mean governments will simply postpone reforms.

Even if the governments accept austerity conditions and initiate reforms, they will be tempted to issue short-term bonds not exceeding three years since costs will be lower. Which means one-third of the borrowings needs to be refinanced every year. For countries with 100 percent debt-to-GDP ratio, one third of the GDP will be used for refinancing, putting them in a vicious debt trap. Most importantly, will the ECB be able to wind up the program at a later stage?


GBP/EURO – 1.2604
GBP/US$ – 1.5928
GBP/CHF – 1.5232
GBP/CAN$ – 1.5638
GBP/AUS$ – 1.5436
GBP/ZAR – 13.1431
GBP/JPY – 125.82
GBP/HKD – 12.3628
GBP/NZD – 1.9844
GBP/SEK – 10.7429

EUR: The single currency continued its upward journey yesterday following European Central Bank’s official announcement that it would buy short-term sovereign bonds in unlimited quantities, subject to strict budget conditionalities. Markets had already priced in a lot of what Draghi had to eventually announce yesterday, given the numerous leaks that hit the wires the previous day. The EUR/USD pair surged to its session high of 1.2649 following ECB’s decision to keep interest rates unchanged at 0.75 percent while the GBP/EUR cross tumbled to 1.2582, as many investors were expecting a rate cut. Moods were dampened later as the ECB downgraded growth forecasts for 2012 and 2013. Focus today shifts to the non-farm payrolls number due from the other side of Atlantic. The GBP/EUR pair opens at 1.5968 this morning.

USD: Sterling hit against a 3-1/2 month high of 1.5943 against the greenback yesterday as risk sentiments improved after Mario Draghi’s press conference, pushing risky FX and equities across Europe higher. The Bank of England kept its interest rate and further quantitative easing on hold as expected and provided not further guidance. We have the UK industrial production number coming out strongest in 25 years, indicating the economy is gradually gaining momentum. Focus is however expected to remain on US non-farm payroll data due later in the day and if yesterday’s ADP employment number is anything to go by, we can expect a decent payrolls reading today. Today’s jobs number is particularly important since it will have serious bearing over next week’s FOMC meeting and any subsequent decision on further accommodative measures. GBP/USD opens at 1.5968 this morning.

Have a great weekend!


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