Ahead Of The ECB

  • European Central Bank December Meeting,
  • Thursday January 21st, 1245GMT 
  • Current rate 0.05%, expected unchanged

December Meeting

Investor expectations heading into the ECB’s December were decisively Dovish expecting the ECB to cut its deposit rate and also increase and extend int quantitative easing program. These expectations were so strong in fact that the Euro was down nearly 1000 pips from the October meeting at which the ECB first aired its considerations of such moves. Draghi has a reputation of “over-delivering” in terms of policy adjustments and players were clearly banking on the EU chief doing the sae again today, anticipating that the Euro would be set sharply lower. However, this was not to be the case.

The ECB did indeed cut its deposit rate, in line with the expected 10bps reduction and it did also announce that QE would be extended, now set to run into March 2017 at the least, however there was no expansion of QE. Although the range of assets approved for purchase has been increased, the actual pace of QE, currently at 60bn Euros a month, was not increased.. These moves were a shock to market participants considering QE expansion a near certainty and EUR reacted sharply higher in response to the news as players took profit on EUR shorts held heading into the meeting as the very crowded EUR short trade has now seen a decent clear out.

Alongside the announced policy adjustments the ECB also revised lower 2016 inflation forecast to 1% from 1.1% and also 2017 to 1.6% from 1.7%. Draghi did however highlight that the EZ economy is in fact growing, stating that credit conditions are improving and QE is working.

Whats Happened Since

EUR has remained firm against the US Dollar in the wake of the ECB’s December meeting, clinging to its post December ECB highs. Data since the last meeting has displayed a theme common among the G3 economies, with employment improving but inflation still under-performing.

On the positive side:

  • EZ 3Q GDP printed in-line with expectations
  • EZ Dec Manufacturng PMI beat expectations
  • EZ Nov CPI beat expectations
  • EZ Nov Unemployment Rate beat expectations

On the negative side:

  • EZ Dec Services PMI undershot expectations
  • German Dec CPI missed expectations
  • EZ Nov Retail Sales undershot expectations
  • EZ Nov Industrial Production undershot expectations
  • EZ Dec CPI missed expectations

The minutes from the ECB’s December meeting revealed a deep rift within the ECB camp. The decision to cut deposit rates was not a consensus call and many members felt that the EZ economy is on the path to recovery and further easing would likely yield a negative effect. In contrast to this there were also some members who felt that more aggressive cuts were necessary.  Investors had been expecting more aggressive action by the ECB at its December meeting and it appears clear now that the juxtaposed view of these opposing sides within the ECB tempered the actions initiated.

The Global Picture

Since the ECB’s December meeting there have been some key developments. In terms of largest impact on the Euro and the considerations of ECB members we have seen a return to the fore of concerns surrounding the slow-down in China and the subsequent global equity volatility stemming from a sharp scaling back in investor risk-sentiment. This equity market volatility has worked to keep EUR supported as via is inverse correlation with risk we are generally seeing EUR appreciate as hedges and carry trades are unwound.

Secondly, and likely to be equally as prominent in the ECB’s discussions, is the continued Oil prices declines which have dominated markets. Central Bankers have been patiently waiting for Oil prices to rebound since summer last year but prices have continued to slide as the global supply glut deepened, taking Crude to below $30 for the first time in 12 years and consequently putting great pressure on the EZ inflation outlook.

Expectations For This Meeting

Given the internal ECB rift exposed by the December meeting minutes it seems unlikley that the ECB will enact any further action at this meeting and so the key will be the accompanying statement and press conference. With Oil prices declines continuing to marr the inflationary environment it seems reasonable to expect a downward adjustment to the ECB’s inflation forecast, as we saw with both the Fed and the BOE. Whilst inflation expectations remain depressed the EUR is remaining supported due to risk-off lows. With EURUSD sitting right in the middle of the 2015 range the ECB will be keeping a close eye on any further strength and any moves towards 1.15 will likely be met with heavy Dovish rhetoric such as they were last year. Indeed, Dovish rhetoric is likely to be the name of the game on Wednesday with the ECB leaving the door open for further policy easing but giving current measures more time to take effect.

Trade Ideas

EURUSD has remained in the range formed in the wake of the post-Dec ECB spike, hemmed in by support at the 1.08 level and resistance at 1.10. Dovishness from the ECB this week should  see a break of 1.08 which sets up a short opportunity on the retest of the broken 1.08 support from below, if price action confirms the trade.   Alternatively, if the ECB isn’t as Dovish as markets expect (they may wish to avoid stoking easing expectations once more following the market reaction in Dec) then we cold see EURUSD take out that 1.10 area. If we do make it above that area I would look to sell a retest of the late 1.10 area Sep 2015 lows.