Euro Dips Further After ECB Flags FX Overshoot In Minutes

Ok, so headed into the ECB minutes, the euro has managed to completely reverse its late Wednesday gains against the dollar as traders seem to have suddenly remembered that prior to Trump crashing and burning and prior to everyone getting a look at the Fed minutes, Reuters reported that Mario Draghi will not in fact use his Jackson Hole speech to signal anything about an ECB policy shift:

The tepid inflation outlook we got in the July Fed minutes and renewed concerns about fiscal policy stemming directly from Trump’s trials and tribulations put the policy divergence theme back on the table in terms of whether the US is actually as far ahead of Europe has everyone thought headed into the year.

That said, the ECB is now dealing with a currency that’s surged since WSJ tipped Draghi’s upcoming Jackson Hole speech and a decidedly uncertain geopolitical backdrop.

What you’re looking for in the ECB minutes is commentary on FX impact vis-a-vis inflation and also hints about the future of QE after December. Here’s a bit more color from Bloomberg:

With the trade-weighted euro gaining 8% in the past six months, market participants will want to know what the ECB is thinking about financial conditions and how that’ll influence its normalization and exit strategy. In this environment, think taper and not tighten. As Fed Governor Lael Brainard said in a recent speech on balance sheet normalization, while raising rates or reducing QE may have a similar impact on growth and inflation, the latter probably has less influence on a currency. Given the euro has strengthened a great deal on the convergence trade, such an approach may be the ECB’s only option to tighten without sending the currency so high it wrecks reflation.

Ok, and with that, here are the highlights from the minutes (also via Bloomberg):

“The appreciation of the euro to date could be seen in part as reflecting changes in relative fundamentals in the euro area vis-a-vis the rest of the world” but “concerns were expressed about the risk of the exchange rate overshooting in the future,” European Central Bank says in account of July 19-20 policy meeting.
“Looking ahead, the Governing Council needed to gain more policy space and flexibility to to adjust policy and the degree of monetary policy accommodation, if and when needed, in either direction.”
“The overall degree of accommodation was determined by the combination of all the monetary-policy measures”
- “The asset purchase program would continue to be a key instrument if the Governing Council assessed the sustained adjustment of inflation at risk”
- “In this context, it was also suggested that the stock versus flow effects of the asset purchases be considered.”
“A suggestions was made that some consideration be given to an incremental adjustment in the language on forward guidance, because postponing an adjustment for too long could give rise to a misalignment between the Governing Council’s communication and its assessment of the state of the economy, which could trigger more pronounced volatility in financial markets when communication eventually had to shift”

**************

Here’s the knee-jerk in the euro: