Last Thursday, the European Central Bank (ECB) delivered one of its most-awaited monetary policy decisions of the year. It already suggested at the last meeting that it will ease the policy further – and it did.
However, the way it did so and the way it chose to communicate the decisions were confusing enough to send the wrong message to the markets. As such, despite the ECB vehemently criticizing the high exchange rates on the Euro pairs, the market squeezed higher with the EURUSD remaining very well bid.
What Did the ECB Announced in December?
The first thing that disappointed the markets was the extension of the ECB’s pandemic emergency programme (PEPP). While it was extended until March 2022 by EUR500 billion, the market expected the extension to go until June 2022. Also, the way Christine Lagarde, the ECB’s President, explained why they opted for March, looked rather hawkish than dovish.
She argued that the ECB has no reasons to believe that the economy will continue to be impaired by the end of 2021. As such, instead of sending a dovish note, as one would be inclined to think giving the easing measures, the ECB managed to deliver just the opposite.
Moreover, the ECB announced improved conditions for its TLTROs programs. These are just loans offered to commercial banks under extremely attractive conditions (i.e., negative interest rates). However, while the ECB did lose the terms, it tightened the conditions for the banks to access them. In other words, it is highly likely that the new TLTROs will have little or no success because few banks will be able to satisfy the conditions needed to access the funds – another hawkish signal for the Euro.
Therefore, the Euro bounced across the board, with both EURUSD, EURJPY, and other Euro pairs making new highs. While Lagarde did try to talk the Euro down by saying that the ECB monitors the exchange rate very closely, there is nothing that the central bank can really do unless it acts on its policies.
In other words, the ECB managed to deliver exactly the opposite of what its intentions were. Instead of delivering easing monetary policy with a dovish message, it managed to deliver easing monetary policies with a hawkish message.
Like a twist of fate, it made it even more difficult to solve for the higher EURUSD exchange rate, as it puts tremendous pressure on inflation and inflation expectations.