Draghi derails the euro

Mario Draghi, the European Central Bank (ECB) President, surprised global financial markets last week by cutting key benchmark rates. The ECB also announced a stimulus to help the euro zone economies.

The ECB reduced key benchmark rates by 10 basis points (bps) to 0.05 per cent. It went on to announce that it will purchase asset-backed securities (ABS) and covered bonds issued by MFIs. This stimulus programme will kick off in October and the details of this programme will be announced after the ECB’s next meeting, scheduled on October 2.

Why the stimulus?

The subdued outlook for inflation and the weakening growth momentum were the major factors that prompted the ECB to come out with this stimulus package, which it states is an unconventional instrument. Euro area inflation (consumer price index – CPI) was 0.3 per cent in August, down from 0.4 per cent in July. The inflation is much lower than the ECB’s target level of 2 per cent. Inflation rates have been coming down continuously from the 3 per cent level in late 2011.

On the growth front, the recovery has stalled. GDP growth slowed to 0.04 per cent in the second quarter this year from 0.2 per cent growth recorded in the first quarter. Growth has been stuck in the 0-0.2 per cent zone over the last few quarters.

Impact on the market

The stock market seems to be rejoicing after the ECB’s announcement. Germany’s stock index, the DAX (9,747), is up 3 per cent. The momentum could continue, as the index looks bullish to target 10,200 now.

But the currency took a strong hit from the ECB moves. The euro (1.2949) tumbled 1.4 per cent against the dollar last week. The outlook is bearish for the euro. It could fall to 1.2750 in the short term and may decline to 1.25 and 1.2250 levels over the medium term.

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