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European Central Bank, Frankfurt am Main | Source: Mikka Luster, Flickr, CC

A dovish Draghi prevails over confused financial markets

By Paul Lirette, Senior Economist, CASE

The European Central Bank (ECB) sent mixed messages to financial markets on Thursday, with an announcement that contained both hawkish and dovish tones.

On December 8th, the ECB revealed that it will extend its monetary stimulus to the Eurozone by 9 months, or beyond, if necessary, but that the pace of monetary stimulus will be lowered from € 80 billion to € 60 billion starting in April.

The mixed messages appeared to surprise currency markets, where the euro/USD witnessed a spike, which failed to sustain, and subsequently moved sharply lower (dropping from a high of 1.0874 to a low of 1.0637). Meanwhile, benchmark German 10-year bund yields rose nine basis points to 0.44 percent but finished the day at 0.38. The pan-European Euro Stoxx 600 index also dropped immediately following the announcement, but recovered to close the day up by 1.23%.

The financial market volatility that was created by the ECB announcement was eased during a regularly scheduled press conference with ECB president, Mario Draghi, who reassured investors that the aim was not an outright winding-down of quantitative easing and that easy monetary policy will remain intact throughout 2017.

It is believed that the decision to extend the accommodative stance hinges on weak inflation, which is only , as well as the fact that many EU members, , are set to hold general elections in 2017, which often plays a role in financial market uncertainty.

Meanwhile the U.S. dollar rose 0.9 per cent against a basket of major currencies, as the ECB news comes just one week ahead of the U.S. Federal Open Market Committee meeting to discuss possible rate hikes (which many are expecting a hawkish outcome given the relatively more robust growth in the U.S. economy). Meanwhile, the S&P 500 closed at an annual high on December 8th, prolonging its recent strong bullish trend.

For the ECB, an extension of accommodative monetary policy appears to be the right move, especially given that a number of Eurozone economies continue to struggle. However, a high degree of political instability in the EU, such as the recent referendum in Italy, and lingering debt overhang make it clear that monetary policy is only one piece of the puzzle.

CASE — Center for Social and Economic Research is an independent, non-profit economic and public policy research institution, established in 1991 in Warsaw.

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