Mario Draghi’s broken promise spooks global markets

Mario Draghi’s broken promise spooks global markets

Good morning and welcome to today’s foreign exchange market commentary on Friday, the 3rd of August.

ECB President Mario Draghi’s failure to make good of his promises made last week, spooked global markets Thursday. Draghi’s strong and unprecedented statement that was interpreted as a strong signal to restart the Securities Market Program by the ECB where the central bank buys bonds of peripheral countries from the secondary markets to bring down borrowing costs seems premature. It seems the head of Bundesbank Jens Weidemann has managed to prevail over Draghi this time around, after expressing reservations last week following Draghi’s overly bullish statements. Nonetheless, ECB along with the just-born European Stability Mechanism remains the only institution that can save the euro from breaking up.

The ECB must make its intentions clear at the onset of reducing Spanish and Italian 10-year borrowing costs to at least 200 basis points below July averages. German diplomats have recently dismissed Spain’s high borrowing costs, arguing the Iberian nation had borrowed at similar rates in the 1990s. Unfortunately they missed a key point; high inflation in Spain in the pre-euro era and a stronger GDP growth, thus ignoring the difference between real and nominal rates.

Countries that are following the committed reforms path should be helped by the ECB in bringing down borrowing costs. Extending the Securities Market Program over long duration would allow the EZ to establish the legal and institutional framework required for more integration, as agreed to in the EC meeting in June.

Additionally the pace of deficit reduction needs to be slowed down as demand in short run decides output and public demand can’t be replaced by private spending until market trust is restored. To support demand effectively, structural reforms should be initiated to allow faster growth over the long run. That being said, everything depends how soon the ECB takes out the bazooka. Or else, the euro will become indefensible, financially, politically and socially very soon.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2724
GBP/US$ – 1.5522
GBP/CHF – 1.5297
GBP/CAN$ – 1.5604
GBP/AUS$ – 1.4794
GBP/ZAR – 12.9650
GBP/JPY – 121.48
GBP/HKD – 12.0434
GBP/NZD – 1.9083
GBP/SEK – 10.5401

EUR: The single currency slumped yesterday after ECB President Mario Draghi decided to keep monetary policy unchanged despite making bullish comments last week. The markets, anticipating a firm plan to deal with the current crisis, were clearly disappointed after Draghi said the central bank nay undertake open market operations shortly to meet its objectives, without giving out any numbers. Draghi’s vague statement on restarting the Securities Market Program where the ECB buys peripheral bonds from the markets pushed the single currency down while equities around the world crashed. The EUR/USD pair plummeted to 1.2140 while Spanish and Italian 10-year borrowing costs shot up. The euro gained some ground against the greenback and the cable today morning, helped partially by stronger than expected European PMI numbers and opens at 1.2210 and 1.2725, respectively this morning.

USD: Despite the recent spate of weak UK economic numbers, the Bank of England decided to keep interest rates unchanged yesterday in its latest policy meeting. BoE also refrained from announcing further assets purchase and decided to wait some more time for the effects of its £50 billion stimulus announced last month. The GBP/USD pair remained steady initially after Thursday’s MPC decision not to initiate another round of quantitative easing, but weakened as the day wore on and finally closed at 1.5495 as investors were left disappointed in the absence of solid plans. UK services PMI is due this morning while the non-farm payroll number is due from the other side of the Atlantic in the afternoon. The GBP/USD pair opens at 1.5530 this morning.

Have a great day!

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