EUR short squeeze continues

The euro (EUR) rallied more than 1bps against the US dollar (USD) on a virtually unchanged policy statement and a Q&A session in which Draghi noted that the ECB could add to the set of current of policies if there was an unwanted tightening of credit conditions. The EUR's reaction was not the result of anything divulged at the press conference; rather, the lack of revelation caused the markets to move. 

Draghi's reiteration that inflation would remain low in the months ahead despite its recent rebound initially caused the EUR to move lower. Draghi noted that the recent improvement in inflation had not changed the bigger picture from the ECB's point of view. A lack of "credible perspective" on the Greek repayment programme added to the pressure on the EUR. However, the EUR reversed its losses and began to rally when Draghi advised that markets must get used to periods of higher volatility, referring to higher German Bund yields. 

ECB board member Benoit Coeuré's comment on the front-loading of QE ahead of the quieter summer months was immediately categorised as a market technicality and not an attempt to cap moves higher in German yields. The markets priced out their initial over-reaction, which had led to a 140-pip fall in EUR-USD. The short squeeze in EUR-USD continues.

Draghi's relaxed stance on higher German Bund yields suggests the ECB will not attempt to reinforce the effects of QE, meaning it may also be comfortable with a higher EUR. However, the ECB policy statement still lists the passthrough effects of monetary policy, in particular the exchange rate, as risks that will be monitored closely as the central bank tries to achieve the inflation target, says Standard Chartered. 

"Since early March that EUR-USD has shifted from a one-way trade lower to more range-bound trading. EUR-USD weakness is expected to resume in Q2 and Q3 as the first Fed rate hike approaches. EUR-USD is seen at 1.08 at end-Q2-2015 and 1.05 at end-Q3-2015", accroding to Standard Chartered.