ECB Decision: What to Expect

Despite the Irish debt debacle, a handful of members of the European Central Bank (ECB) Governing Council think that it’s about time the central bank withdrew its stimulus.

One of the giddy central bankers is Vice President Vitor Constancio, who suggested that the region’s moderate-yet-sustained economic recovery calls for a tighter monetary policy. Executive Board Member Gertrude Tumpel-Gugerell shouted “Hear, hear!” to the VP when she said that the swagger the economy has been showing is enough for banks to continue their lending without relying so much on the ECB.

And they may just be right! Wasn’t it just last week that PMI reports from France and Germany surprised the markets with better-than-expected figures?

Germany’s services PMI for November came in at a 39-month high at 58.6, beating the consensus by 2.8 points, while its manufacturing PMI printed at its four-month high at 58.9. The French economy also showed some sizzle when the services PMI showed an increase to 55.7 versus the measly 54.8 forecast and the manufacturing PMI clocked in 2.5 points better than the forecast at 57.5.

Of course economic data ain’t the only factor that’ll determine whether the ECB should tighten their monetary policy or not. Bear in mind that debt concerns have been plaguing the euro zone once more and perhaps these will affect the ECB’s decision more than anything else. It doesn’t help that the EU might be forced to dole out a couple more bailout packages, one for Spain and another for Portugal, soon.

The ECB also has to consider the possibility that these heavily indebted nations will have to implement spending cuts too. Gasp! Not the A-word again?!

So perhaps now might not be such a good time to raise interest rates. Higher borrowing costs, as well as austerity measures, could further hurt economic growth. Aside from that, higher rates would make it more difficult for governments to refinance their sovereign debt, which can’t be good for those nations already in fiscal trouble.

Where does this leave the euro?

To recap, the euro had been on a rather bullish run from June to early November, with EUR/USD rising over 2000 pips. However, once sovereign debt concerns popped up, investors shied away from the euro, causing it to drop across the board. Over the past month, EUR/USD has fallen 9% from its peak and is now sitting right smack on the 1.3000 handle.

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It’ll be interesting to see what effect the ECB statement could have on euro sentiment. If Mr. Trichet comes out and displays confidence, it could help appease the markets and help the euro recover from its steep fall this past week. On the other hand, if his statements are perceived to be dovish and that the euro zone may need even more stimulus, it may be start a bearish run that could lead EUR/USD back down to test major support levels at 1.2600 and 1.1900. Better stay tuned!