Draghi's medicine not strong enough for euro
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Foreign Exchange

Draghi's medicine not strong enough for euro

The euro took a tumble as European Central Bank president Mario Draghi quashed hopes that the bank was going to rescue the region’s debt markets.

Initially, EURUSD rallied up to a high of $1.3459 after the ECB cut its main lending rate by 25 basis points and introduced new non-standard measures to support the liquidity at eurozone banks. The institution said it would conduct two longer-term refinancing operations, loosen collateral rules for banks to obtain funding and lower bank reserve ratios to free up capital.

Ulrich Leuchtmann, head of currency research at Commerzbank, said easing the collateral rules was more than just a technical detail.

“The more these rules are eased, the more likely peripheral countries are to protect negative current account balances against a flight of capital,” he says.

That was taken as a positive for the euro, given that the easing of stress in the eurozone financial system made the survival of the European monetary union more likely.

However, the EURUSD plunged, hitting a low around $1.3310 when it became clear that the ECB was not about to take bolder action to head off the eurozone debt crisis and become the region’s buyer of last resort.

Draghi revealed that the decision to cut rates had not been unanimous, giving little sign that the ECB was prepared to cut rates further to support growth.

More importantly, Draghi stressed that the ECB was not set to ramp up its bond-purchasing scheme, something that many had been expecting after his comments last week that “other elements might follow [once a] fiscal compact” had been agreed between eurozone states.

Draghi now clarified that those other elements did not include bond purchases, saying that the central bank did not have target levels for eurozone government bond spreads or bond yields.

And he delivered another blow to euro bulls when he ruled out lending to the International Monetary Fund. Some had seen this as a way for the central bank to circumnavigate rules over sovereign-debt purchases.

John Higgins, at Capital Economics, said Draghi’s message could not have been clearer: don’t expect the central bank to save the eurozone with bigger purchases of government bonds or by lending to the IMF.

“We have warned already that courageous steps from the ECB would not prevent the eurozone from breaking apart, but in their absence, the chances of some sort of break-up must surely be greater,” he says.

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