Traders at the Frankfurt stock exchange. Image Credit: Reuters

London: With trade tensions in the background, the market is digesting signals from the ECB. The euro jumped to a seven-week high yesterday as Draghi disappointed some observers who had expected the bank to be more dovish, and this is bad news for European exporters. Add to that the risk that today’s US payrolls may weigh on the dollar.

A strong currency could be the next big risk for European equities, according to strategists at Societe Generale. Euro Stoxx components generate almost 60 per cent of their revenue from outside the bloc (17 per cent from the US and the rest from other countries), making them highly sensitive to the euro-dollar. The euro weakening ahead of quantitative easing acted as a strong support for the region’s results, while its bounce in 2017 was part of the reason earnings-per-share growth stalled in 2018, they say.

Looking at the purchasing power parity level ($1.37 currently), the euro is well below its equilibrium level, SocGen says. The bank’s economists forecast the EUR/USD to reach 1.16 by year-end, with US economic growth slowing down. They see a US recession in early to mid-2020. Should the outlook darken, the Fed has already opened the door to cut rates.

So it’s no surprise investors were disappointed with Draghi’s announcements, especially after other central banks turned more dovish this week in reaction to trade tensions. Australia cut interest rates on Tuesday for the first time in three years, there’s anticipation of more stimulus in Japan, while India took an accommodative stance and cut its key rate on Thursday.

Commentary that some ECB officials raised the possibility of rate cuts, or QE, didn’t have much impact on equity markets — and for good reason as the hands of the central bank appear tied. Its balance sheet has ballooned after four years of QE and it reduced the pace of its asset purchase program. Additionally, the refinancing rate is at zero and real interest rates have been negative for several years. By contrast, the Fed can afford rate cuts and monetary easing, which could weaken the dollar fast.

Is there a silver lining in sight for banks? The ECB pledged to help lenders refinance cheaply with its new round of TLTRO from September. The conditions triggered a short-lived spike for the industry’s shares. Citigroup analysts said the overall announcement is relatively negative, but will help lenders’ earnings in Spain and Italy. With Draghi retiring in October, this may be his last gift to a depressed sector, while the name of his replacement is still unknown.