Will Draghi’s Bazooka Hit Gold?

Yesterday, the European Central Bank cut interest rates and extended its asset-purchase program. What does it mean for the gold market?

Draghi Pulls Out the Bazooka

As expected, the European Central Bank further eased its monetary policy. Draghi did not want to disappoint the markets again, as he had done in December 2015. Actually, he delivered a bigger stimulus than expected. What are the ECB’s key monetary policy decisions?

First, Draghi cut interest rates. The main refinancing rate was reduced by 5 basis points to 0 percent while the marginal lending facility rate was decreased by 5 basis points to 0.25 percent. Finally, the deposit rate was slashed by 10 basis points to -0.40 percent. Therefore, negative interest rates were strengthened in the Eurozone. Each of these cuts will be effective March 16.

Second, the ECB expanded its bond-buying program. The monthly purchases under the asset purchase program will be expanded from €60 to €80 billion starting in April. Moreover, Draghi made investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area eligible for ECB purchases. By including high-quality non-bank corporate bonds in the list of eligible securities Draghi probably wanted to ease possible fears that the quantitative easing would run out of eligible securities.

Third, the ECB decided to launch four rounds of targeted longer-term refinancing operations (TLTROs) with a maturity of four years. These are long-term loans to banks aimed at boosting lending activity (the more the banks lend, the bigger and cheaper the ECB loans). Importantly, the ECB will charge interests from 0 percent to “as low as the interest rate on the deposit facility”. Therefore, the ECB decided to simultaneously charge commercial banks negative interest rates on their deposit and pay them money for lending money in targeted longer-term refinancing operations. Welcome to the special world of central banking. Abandon common sense and enjoy the magic letters: NIRP, QE, TLTRO and so many others! But let’s be serious – it seems that the negative rate on TLTROs was implemented to compensate the banks for the extra costs of negative deposit rate and eased the investors’ fears about the impact of NIRP on the banks’ profitability.

Draghi’s Bazooka Shot Missed Gold

Initially, the ECB’s announcement seemed to work as usual. The euro dropped sharply while the U.S. dollar hit a new high for the week. The price of gold declined below $1,240. However, Draghi’s plan worked… for all of 15 minutes. During his press conference, the euro and gold staged a dramatic U-turn. The euro recovered to a three-week high against the dollar while gold ended the day with a 1.5-percent gain, the biggest single-day gain in a week. Why did gold rebound? Well, Draghi suggested that there would be no further cuts. He told journalists at the press conference: “from today's perspective and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further”. The markets interpret Draghi’s comment as signal that there are limits to how low rates can go. Some analysts even speculate that the President of the ECB made a compromise with the Governing Council – one big bazooka shot, but no more.

Conclusions

To sum up, Draghi not only did not disappoint the markets (unlike in December) but delivered monetary stimulus bigger than expected. However, he undid the very stimulus he had hoped to achieve by suggesting there would be no further cuts. The market response to the ECB’s decision implies that investors lost their confidence in the central banks’ abilities to control the economy, as even a big monetary stimulus was interpreted negatively as a signal that the ECB was approaching the limits of monetary policy. The current depressive sentiment among investors is very bullish for the gold market. In the past, the ECB’s monetary easing led to a stronger US greenback and lower gold prices. But yesterday gold showed resistance and rallied on safe-haven demand as the ECB rattled the markets.

Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium-term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.