Euro Soars On Draghi Remarks

As expected, the European bank left monetary policy unchanged but the rate announcement was never the main focus of the day -- instead all eyes were on ECB President Draghi's press conference and Super Mario did not fail to deliver. Comments from the head of the ECB drove the EUR/USD to a one-week high and EUR/JPY to an 18-month high. While Draghi started his press conference with a grim tone, saying that the economy will remain weak into 2013 with a gradual recover later this year and risks to the downside, by the end of the Q&A session, investors realized that his satisfaction with improvements in financial market conditions means the ECB is less inclined to increase stimulus. A rate cut was not discussed at all and that in of itself was enough to drive the EUR/USD sharply higher.

Markets Back To Normal
With financial market sentiment improving significantly, tail risks removed and funding conditions at satisfactory levels, Draghi believes that the financial markets have now returned to normalcy. This is not to be mistaken with normal economic conditions and the ECB is "not thinking about an exit" from ultra easy monetary policy but the central bank's primary goal was to stabilize the financial markets and it appears that they are happy with what has been achieved. Strong capital flows are returning to region, bond yields have fallen and inflation risks are broadly balanced. Draghi's reminder that the mandate of ECB is not full employment but price stability suggests that the ball is being thrown back to European governments because reducing unemployment should be their responsibility.

Nonetheless, the ECB will keep their stimulus in place until there are stronger signs of recovery. According to Draghi, economic indicators still signal weak activity and the debt crisis along with geopolitical tensions pose a continued risk to Europe's economy. There is still a significant amount of fragmentation in the region and fiscal consolidation is unavoidable but for the most part, their economic outlook remains unchanged and this was the main reason why their decision to hold rates steady was unanimous.

Worst Is Over
The main takeaway from today's meeting is that the ECB is no longer in crisis mode because the battle with the financial markets have been won. The markets have stabilized and the worst is over but monetary policy needs to remain accommodative because growth is weak.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management