EU: ECB Draghi To Open The Liquidity Flood Gate?

(EU) ECB Draghi: If premium on Government borrowing hurts monetary policy transmission then dealing with them falls within the ECB’s mandate

• ECB is ready to do whatever is necessary to preserve the Euro within its mandate, “and believe me, it will be enough.”
• Reiterates that ECB priority is price stability; does NOT want to supplement government actions.
• Euro Area much stronger than what has been acknowledged.
• EU has lower deficit and debt and higher social union compared to US.
• Progress on fiscal and reforms have been remarkable over the last six months.
• Believe euro is irreversible.
• The interbank market is not functioning across countries.

How to interpret this speech?

ECB Draghi stated that “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough,” and “… to the extent that the size of the sovereign premia (borrowing costs) hamper the functioning of the monetary policy transmission channels, they come within our mandate,” which means that ECB is going to buy Spanish and Italian bonds to drive their yields to sustainable levels, or good news for the Euro as the reason for the continued Euro sell-off is partially due to the lack of action by the leaders and contagion fear.  This promise of action from ECB addresses both issues in my opinion and could bring stability back to the Euro for at least a couple of months, depending on the measures implemented.  I believe market is going to be on ultra alert in the next few days and look forward to the next ECB meeting for more details.

I believe perception is key to Forex and perception is good right now for the Euro.  However, remember that the situation in Greece, Spain, and Italy have not disappeared, this effectively just delays the inevitable, and ECB could only do so much…  Market will probably consolidate its gains today as traders are still looking to sell on rallies… The real mover will probably be next ECB Meeting on August 2, and I’ll anticipate some pre-buying ahead of the meeting as ECB Draghi could announce a third round of LTRO (Long-Term Refi Operation) or SMP (Securities Markets Program) following today’s comments with concrete action.  Verdict: Wait for EURUSD to drop and buy on dips early next week.

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