It would appear that we are going through one of those `wait and see` times. Just wishin` and hopin` and thinkin` and prayin` that the actions of the ECB or the electric shock of NFP day will kick start a market seemingly at a loss for direction. The overhang of positioning from last year has hung heavily over most markets and it is this factor rather than any new evidence that has shaped movements in EM, equities and currencies.
For today, even if Mr Draghi manages to convince his council that they really should alert the world to a greater problem in the Eurozone, whilst instituting measures that will do nothing to solve it, I can`t see the waters clearing. An interim measure of a rate cut of 10/15 pips would be the sign of an institution belatedly recognising the problem, but having absolutely nothing in their existing armoury to combat it. Monetary policy has been a sometimes severe, sometimes over reactive but effective instrument for central banks and monetary-authorities in the fight against inflation. Because of the finite nature of its downside (and the law of diminishing returns!) it is not as effective in isolation against deflation. As I mentioned the other day, combating a nebulous composite inflation number is impossible. There are clearly some parts of the eurozone that are currently experiencing deflation, but disinflation is the experience more widely, and for Germany, pretty much OK!
The ECB are in a difficult place. To tinker with rates, ie. a cut of less that 25bp would not impress the market, and yet the ECB may believe that they have to send `a message` about their concern. The right thing to do is to restate Mr Draghi`s recent statement that there is nothing to worry about yet,`The risks of deflation and inflation are limited at this point in time`, stick to their guns and do nothing. If the urge to act is overwhelming, there is always the prospect of a myriad of money market measures that they could announce – and probably will. All the time there is an elephant in the room and its name is QE.
Now I`m not one to promote QE as the cure to all things, but plainly as a way to directly generate liquidity into a system, it is effective, and actually should have been used a long time ago. Why not? Germany! I don`t need to tell you the history behind this opposition, nor how hard wired it is, but it is a very significant obstacle. The legality of it could be finessed if the will was there but that looks unlikely.
So the likelihood of being pressurised into making some announcement looks great. Although a lower euro as a result may be welcome from an orthodox anti inflationary stance, I get the impression that at this delicate time Mr Draghi cannot afford a sharply weaker currency, and once those wheels start rolling, they can be hellish difficult to stop. There are enough doubts and uncertainties still around the periphery, and the negative comments such a fall would engender, and the lack of any viable policy instrument to stem any sharp fall would only further undermine confidence. Rock and a hard place time; no time for indecision, and too early to be brave!
