Euro ‘whatever it takes’ Phase 2

Markets were shocked last night when the European Central Bank (ECB) raised rates by 50bps not the consensus 25bps.  To be clear now, that raised their deposit rate immediately and all the way up to….zero. Whilst the first hike in 11 years and largest hike since 2000 saw the EUR surge off parity with the USD what happened next is arguably more important.

But first let’s look at the context.  In 2012 amid the European Crisis that first highlighted the fundamental flaw in a common currency amongst disparate economies and sovereign balance sheets, then ECB chief Mario Draghi uttered 3 words that transformed Euro markets thereon, pledging publicly the ECB would do “whatever it takes” to save the common currency of the Eurozone.  What ensued was trillions of printed EUR with the ECB buying all manner of financial instruments and setting negative interest rates, joining Japan and Switzerland in this unprecedented policy step.

Fast forward 10 years and the Eurozone has another crisis to manage and that is fighting inflation quickly heading to 10% amid clear recessionary fears but particularly in ‘never recovered in the first place’ economies like Italy.  Add to that the energy and food impacts of the Ukraine conflict and you’re looking at quite the mess.  The latest is not without just a little irony, with the now President of the basket case that is Italy, the one and only Mario Draghi being forced to resign as the country is plunged into another political ‘crisis’.  ‘Crisis’ of course in the context that the country has now had 70 governments since the end of WW2 (an average of 1.1 per year).  The problem is that Italy is the 3^rd largest economy in the Eurozone and 8^th in the world.  It matters.

And hence the ‘what happened next’ piece of last night which was ‘how does one raise rates so aggressively amid such disproportionate weakness in your various economies sharing the one currency?’.  The answer, if we are being frank, is you can’t in any clear way, so you use lots of loose words and acronyms.  Enter the Transmissions Protection Mechanism (TPI) which the ECB describe the purpose of which is to "safeguard the smooth transmission of its monetary policy stance throughout the euro area" and "allow the Governing Council to more effectively deliver on its price stability mandate" or how about “can be activated to counter unwarranted, disorderly market dynamics.” And the kicker "purchases are not restricted ex ante."  Ex ante is fancy speak for vibe not facts…  So where Mario used 3 words to say they will print EUR and interfere between various sovereign bond markets ad nauseum to keep the EUR together, Lagarde is deliberately more verbose and vague because she has the issue of rampant, crippling inflation to deal with this time, and the fact they have left it too late I (a shout out to our own RBA here…).

Perversely this isn’t of course new.  The ECB still have their other acronym for loose money, PEPP in play and all ready to redeploy ala “In any event, the flexibility in reinvestments of redemptions coming due in the pandemic emergency purchase programme (PEPP) portfolio remains the first line of defence to counter risks to the transmission mechanism related to the pandemic.”

So you get the picture.  And so did the market.  On outlining the TPI, the market saw right through this, called BS, and the EUR plunged lower than where it started, future rate hike expectations plummeted, and gold, the sniffing dog of future strife and currency debasement, shot up strongly and held.