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Confusion as Carney and Draghi struggle to clarify stimulus exit

Bond and currency markets whipsawed on Wednesday as Europe’s two most influential central bankers struggled to communicate to investors how they would exit from years of crisis-era economic stimulus policies.

The euro surged to a 52-week high against the dollar after investors characterised remarks by Mario Draghi as a signal he was preparing to taper the European Central Bank’s bond-buying scheme — only to drop almost a full cent after senior ECB figures made clear he had been misinterpreted.

Similarly, the British pound jumped 1.2 per cent to $1.2972 after Mark Carney, Bank of England governor, said he was prepared to raise interest rates if UK business activity increased — just a week after saying “now is not yet the time” for an increase.

The sharp moves and sudden reversals over two days of heavy trading highlight the acute sensitivity of financial markets to any suggestion of a withdrawal of stimulus measures after a prolonged period of monetary accommodation.

Laurence Mutkin, head of interest rate strategy for BNP Paribas, compared the speed of the market response and the subsequent attempts by central bankers to steer it to the so-called “taper tantrum” of 2013, when then-Federal Reserve chief Ben Bernanke spooked the US bond market by suggesting the Fed was preparing to slow its stimulus programme.

“[Mr Bernanke] started talking about the taper in the spring, and it wasn’t until the summer that he decided markets had overreacted and he had to calm them down,” Mr Mutkin said.

Eurozone currency and bond markets had seized upon Mr Draghi’s speech, delivered on Tuesday at an ECB conference in Portugal, focusing on his contention that “deflationary forces have been replaced by reflationary ones”.

Although analysts saw the remarks as the first sign Mr Draghi was contemplating an end to his €60bn-per-month bond-buying programme, the speech also called for “persistence” and “prudence” in the future path of monetary policy.

Mr Draghi did not address the issue publicly in a second appearance Wednesday at the conference, and the euro moved to $1.375, a gain of 0.3 per cent on the day, as German bond yields also recovered most of their lost ground.

The Bank of England’s rate-setting committee has become sharply split over whether to raise rates, having voted narrowly 5-3 earlier this month to keep rates near historic lows. Mr Carney and the BoE’s chief economist, Andy Haldane, publicly split over the way forward last week, when Mr Haldane gave a speech suggesting rates should rise just a day after Mr Carney had signalled the opposite.

The BoE governor’s remarks on Wednesday appeared to be an effort to retake the initiative in the debate, though they varied little from those made last week. “Some removal of monetary stimulus is likely to become necessary“ if the economy remains firm, he said.

Alan Ruskin, currency strategist for Deutsche Bank, said “the market is very sensitive to the idea that a number of central banks are, appropriately and belatedly, reassessing the need for emergency policy accommodation.”

Following Mr Carney’s remarks, the policy sensitive 2-year gilt yield hit its highest level since last year’s Brexit referendum at 0.329 per cent, tipping above the base interest of 0.25 per cent for the first time this year. The yield on the UK’s benchmark 10-year debt rose to its highest since May 11, up as much as 10 basis points at 1.196 per cent.

Sterling hit a high of $1.2972, but then it and gilt yields both retreated as traders took more time to assess the Carney remarks. John Wraith, UK interest rate strategist for UBS said “I don’t think he said anything new.”

Additional reporting by Roger Blitz