Mario Draghi: Central bank may be forced to take “exceptional measures”

Mario Draghi: Central bank may be forced to take “exceptional measures”

Good morning and welcome to today’s foreign exchange market commentary on Thursday, the 30th of August.

The summer in Europe promises to be momentous going by recent developments. ECB President Mario Draghi, after lying low for a couple of weeks following his much vaunted public pledge to do “everything to preserve the euro” fired his latest salvo yesterday. In an article written for German magazine Die Zeit, Draghi said the central bank may be forced to take “exceptional measures” as standard monetary policy tools may not be enough to keep prices stable. That being said, and despite important steps taken for direct Spanish bank recapitalization and a banking union, implantation risks of the proposed reforms remain, not to mention the legal challenges including the German court verdict on the constitutionality of the ESM in September. Finland and the Netherlands have voiced their opposition to some of the provisions already, complicating matters further.

Europe’s disparity in competitiveness and production costs, as exemplified by high current-account deficits in the peripheries, may prove to be the most difficult problem to resolve. In the first decade of the euro, unit labour costs in Italy, Spain, Portugal and Greece grew 20-30 percent faster than in Germany. Higher investments relative to domestic savings rate resulted in structural current account deficits in the southern countries while large fiscal deficits in countries like Greece aggravated the matter further. High private sector borrowing in Spain was the equivalent of wide current account deficit.

The eurozone crisis can’t be resolved using monetary tools unless internal imbalances are reduced, which requires not only adjustments in balance-of-payment accounts across Europe, but also fiscal adjustments in the peripheries. That in turn means exchange-rate adjustments for peripheral nations that would reduce production costs compared to the core. This can be achieved through inflation differentials where wages in peripheries grow at a slower pace than in Germany for a number of years to restore competitiveness. But since the Germans remain loathe to inflation, the exchange-rate adjustment can only be achieved through actual price and wage deflation in the peripheries. The ECB’s provisional liquidity can buy time, but only real adjustment can solve the underlying problem.


GBP/EURO – 1.2612
GBP/US$ – 1.5828
GBP/CHF – 1.5152
GBP/CAN$ – 1.5681
GBP/AUS$ – 1.5314
GBP/ZAR – 13.2774
GBP/JPY – 124.48
GBP/HKD – 12.2804
GBP/NZD – 1.9712
GBP/SEK – 10.5241

EUR: The single currency started off on a strong note yesterday after Mario Draghi’s article in German weekly Die Zeit argued for going beyond standard monetary policy tools to keep prices stable in Europe. Calling for “exceptional policy measures” Draghi said when markets are fragmented by irrational fears, the central bank’s monetary signals don’t reach citizens across Europe evenly, adding to speculations that the ECB will announce its intentions to intervene in the secondary bond markets at their next policy meeting on September 6. The strength of euro however proved fleeting with another Spanish autonomous region Andalusia may request financial help from Madrid. Given three indebted regions, Murcia, Catalonia and Valencia has already requested for bailout, it seems just a matter of time before Spain itself is forced to request for a full blown bailout. Markets are expected to remain range-bound ahead of Bernanke’s speech tomorrow though Italian bond auction and German job numbers today morning will attract some attention. The GBP/USD pair opens at 1.2613 this morning.

USD: The cable rallied against the greenback yesterday with the GBP/USD breaching the 1.5800 level to reach an early afternoon high of 1.5855. The pound was unable to hold its ground however as the dollar strengthened on the back of upward US GDP revision for the second quarter and better-than-expected pending home-sales number, and finished the day around 1.5830 levels. We have UK money supply number due today given the Bank of England’s quantitative easing program is back in full swing while we have personal spending numbers due from the other side of the Atlantic for an insight into the Q3 US GDP numbers. It is imperative to say that a lot will depend on tomorrow’s Bernanke speech in Jackson Hole as markets wait in anticipation globally. The GBP/USD pair opens at 1.5836 this morning.

Have a great day!


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