Expect a dovish Draghi, but no QE

Depending on where you come from in the world, the decline in the price of oil can either be seen to be a hindrance or a major help.

Mario Draghi
Source: Bloomberg

It’s clear that the US in particular has benefitted from the 40% decline, with GDP for Q3 exceeding expectations and giving a boost to the world’s largest economy.

For the likes of Venezuela, Russia and Iran, however, it’s a different story. The fiscal outlook for these countries looks ever shakier, as OPEC continues to refuse any opportunity to intervene in the oil market.

To say there is significant debate on how the oil price plunge will affect the outlook for the eurozone would be an understatement. 

Effect on the eurozone

Inflation remains an issue for the eurozone, having fallen to a five-year low in November. While the European Central Bank is expected to keep rates on hold, or at the lower bound in any case, the enticing prospect of additional stimulus in the form of sovereign debt-buying is clearly keeping the bears at bay in terms of risky assets.

The level of opposition from Jens Weidmann from the German Bundesbank also tends to indicate that investors are set to be disappointed – at least until the first quarter of 2015. The measures already in place will need to be given a chance to take hold and have an effect before the ECB uses the last tool in its arsenal.

While it’s highly unlikely that Mario Draghi will make a truly dramatic announcement this Thursday, we can probably expect him to maintain a dovish tone which, to all intents and purposes, will have the same net effect on equities. Bear in mind that we only have to look as far back as July 2012 to see how successful Mr Draghi can be in talking the markets around to his way of thinking. Before the last ECB meeting, the DAX ramped up gains in advance, and it looks like we may be seeing a similar scenario playing out today.

Unemployment remains an issue with the jobless number rising 60,000 last month and the rate remains stagnated at 11.5%. The cause for concern is still there with regards to Italy and France.

The supposed optimism surrounding the investment plan put forward by Jean-Claude Juncker is likely to be exaggerated and temporary – it will be difficult to use €20 billion to support the level of infrastructure projects even if levered upwards. Nevertheless, it’s a step in the right direction with regard to the spending and structural reforms that will be necessary to get the eurozone into a more economically viable space.

Oil prices and the pullback are going to be problematic, and will not help the ECB to assert inflation near its mandated level at 2%. The euro area consumer price index rose by just 0.3% annually in November, with energy prices tumbling by 2.5% over the last year. Sure, the falling price means more money in consumer pockets – and certainly that extra income is more likely to find itself into the real economy that oil producer revenues, so it’s not all bad – but the closer the inflation rate gets to zero, the more difficult it will be to reverse.

Quantitative easing is not a panacea for the eurozone ills, but it may provide some breathing space in a weak economy. The ECB has only one mandate – price stability. If they fail for much longer we may be looking at a lost decade or more.

What can we expect on Thursday?

I think the most we can expect is a possible corporate bond buying roll out – which could assuage investors for the time being, but one does feel that nothing short of Fed-style QE will be enough to send the euro crashing back to lows last seen in summer 2012.

Currently the euro is holding above the $1.24 level but has failed to gain any advantage when testing the upper end of the recent range at 1.2570. The trend is down for the single currency but, given the current consolidation in the dollar which is taking a breather from the spectacular bull run in play since 15 July, we may continue in a range without a catalyst to send the greenback higher. The non-farm payrolls on Friday may well provide this driver.

As dovish as we can expect Mr Draghi to be, getting the balance sheet back to 2012 levels will be no mean feat. However, I fear any additional declines in EUR/USD will not be on the back of a new enlightened, looser monetary tool from the ECB.  Not this week.

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