The ECB is behind the curve and oblivious to it

The euro fell to a two-month low of 1.0812 during the ECB press conference. Some of that was on the US dollar side as retail sales beat expectations but the bulk of today’s 40 pip decline in domestically driven.

The ECB just doesn’t seem to get it.

Lagarde repeatedly highlighted downside risks to growth and even said that “all the data is pointing in the same direction” around poor growth and inflation, yet there was no pledge to do anything about it.

Instead, she repeatedly highlighted data dependence. Lagarde was asked if they considered cutting 50 basis points today and indicated they didn’t even discuss it.

The ECB main refi rate is now at 3.25% and inflation is clearly headed towards target. That’s simply too high for an economy that’s struggling and seeing consistent undershoots in inflation. Lagarde mentioned soft forward-looking PMIs 4-5 times but also dismissed the risk of recession.

Even if there is no recession, there is a high risk that the eurozone is mired in low growth and low inflation. It’s particularly stark because European governments are going to face high austerity pressures in the coming years.

Now the ECB didn’t need to cut 50 bps today but it would have been nice for her to signal a more-dovish stance and to put it on the table for December. Over in the US, you have a much stronger economy and yet the Fed chairman is delivering meme-like dovish pronouncements and already cut by 50 bps.

In a vacuum, higher rates are good for a currency but that’s not what’s happening in the eurozone. Why? The market sees Lagarde as falling behind the curve and it means they will have to cut deeper later, and keep rates lower for longer. There is a high risk the eurozone returns to a low-inflation, low-growth economy and that’s why Goldman Sachs is saying the euro should be the preferred carry funding currency.

This article was written by Adam Button at www.forexlive.com.