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Hello, forex friends! The ECB will be giving its monetary policy decision tomorrow (October 26, 11:45 am GMT), with a presser shortly after (12:30 pm GMT).

There’s therefore a very good chance that the euro will get a major volatility boost. And if you’re planning to trade that top-tier event and you need a quick review of what happened last time, as well as a quick preview on what’s expected this time, then you better read up on today’s write-up.

What happened last time?

  • Refinancing rate maintained at 0.00% as expected
  • Marginal lending rate maintained at 0.25% as expected
  • Deposit rate maintained at -0.40% as expected
  • QE extension until December 2017 (or beyond) at €60B per month maintained
  • Growth projections upgraded
  • Inflation forecasts downgraded
  • Easing bias on QE program maintained

As expected, the ECB announced during the September ECB statement that it was maintaining its monetary policy. As such, all rates were kept steady while the ECB’s extended QE program was affirmed at €60 billion per month.

In addition, the ECB repeated its mantra that rate hikes aren’t coming anytime soon when it said the following:

“The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.”

Moreover, the ECB also maintained its easing bias on its QE program when it reiterated during its press statement that:

“If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the programme in terms of size and/or duration.”

And in the ECB’s press conference after the initial statement, ECB President Draghi revealed that the ECB upgraded its growth forecasts to reflect stronger-than-expected growth.

However, Draghi also revealed that with regard to the ECB’s inflation forecasts:

“[T]here was a downward revision mostly due to the – or mainly due to the – exchange rate appreciation. So there was a certain, I would say, broad dissatisfaction with the inflation.”

Draghi basically hit two birds with one stone in that statement since he eased tapering expectations by expressing “broad dissatisfaction” with the downgraded inflation forecasts while taking aim at the euro’s strength by attributing the downgraded inflation forecasts “mainly” to the euro’s strength.

It’s therefore quite understandable why the euro dropped hard as a knee-jerk reaction to his comments.

Overlay of EUR Pairs: 15-Minute Forex Chart
Overlay of EUR Pairs: 15-Minute Forex Chart

However, euro bulls later jumped back in and pushed the euro higher after Draghi was asked the following question:

“Could you right now commit that we would know the decision about the future of the QE programme in October? Or it will be delayed even further until the December meeting?”

To which Draghi answered as follows (emphasis mine):

“The Governing Council has reiterated it’s this fall as the period when these decisions will be taken because the decisions are many, complex and always one naturally sort of thinks about risks that may materialise in the coming weeks or months. So that is the caution about not specifying a date. Probably the bulk of these decisions will be taken in October.”

Forex traders were pleased with the idea that the ECB may finally announce the future tightening of its monetary policy by October. However, Draghi did dampen expectations a bit when he said later that:

“[We] will announce when we are ready. We think we are going to be ready for much of what we have to decide by October. But as I said, the Governing Council is kind of reluctant to commit to a precise date. The sense is that in October we should be ready but if we are not, then we will postpone.”

The lack of conviction apparently made euro bulls doubt the idea that change will be coming in October, and so follow-through buying in the wake of the ECB presser didn’t quite materialize.

So, what’s expected this time?

  • No change in monetary policy expected
  • Hints at future tightening expected
  • Likely future tightening move would be a tapered QE extension
  • Current QE extension will expire this December 2017
  • QE extension by 9-months after December 2017 expected
  • QE extension at a tapered pace of €30B per month expected
  • ECB not expected to change its tune on interest rates
  • ECB not likely to talk down the euro

How is the Euro Zone economy faring lately?

The ECB won’t be giving an update on its macroeconimic forecasts until December. However, we can gauge how the Euro Zone economy has been performing compared to the ECB’s September Staff Forecasts.

Source: September ECB Staff Forecasts
Source: September ECB Staff Forecasts

And looking at GDP growth, the ECB expects the Euro Zone as a whole to grow by 2.2% year-on-year in 2017. Well, as it turns out, the Euro Zone’s economy grew by 2.3% year-on-year during Q2 2017, which is already faster than the ECB’s own forecasts and is the fastest annual growth in 25 quarters to boot.

Headline HICP, meanwhile, is expected to increase by 1.5% year-on-year in 2017. And it just so happens that headline HICP has been increasing at the forecasted pace in August and September.

Even better, the ECB’s preferred measures for core inflation have been printing better readings.

The first preferred measure for core inflation is HICP less energy. And that ticked higher to 1.3% year-on-year in September, which is the highest reading since 2013 and is already beating the ECB’s 2017 forecast of 1.2%.

Another preferred measure for core inflation is HICP less energy and unprocessed food. And that also came in at 1.3% year-on-year in September, which is also beating the ECB’s forecast of 1.1%.

Given that the Euro Zone’s economy is evolving as expected (or better), it’s highly likely that the ECB will announce future changes to its monetary policy in the upcoming ECB statement and presser.

What’s expected of monetary policy?

So what’s expected of monetary policy? Well, like last time, the general consensus is that the ECB will be maintaining its monetary policy.

But as mentioned earlier, Draghi said last time that “Probably the bulk of these decisions [on the changes in monetary policy] will be taken in October.”

And given that the QE extension will be ending by December 2017, and also given that the Euro Zone economy has been evolving largely within (or better than) the ECB’s own forecasts, the market is expecting Draghi to announce some future changes during the upcoming ECB statement and presser.

And in an October 13 Bloomberg report that cited unnamed ECB officials, “some” ECB board members supposedly favor extending the ECB’s QE program by nine months, but at a tapered pace of €30 billion per month, which is half the current monthly purchase amount.

And according to economists surveyed by Bloomberg last week, the general consensus is that the ECB will likely announce a nine-month extension to its QE program at a monthly pace of €30 billion, which is in-line with what the unnamed ECB officials said.

As for interest rates, the ECB is expected to maintain its forward guidance on interest rates, namely that interest rates won’t be moving up anytime soon.

This is reinforced by ECB President Draghi’s October 12 comment that:

“The ‘well past’ is very, very important in anchoring rate expectations.”

This, of course, is within the context of the ECB’s current forward guidance on interest rates (emphasis mine):

“The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.”

What about the euro?

Draghi isn’t expected to talk down the euro as much (if at all), given that the euro has depreciated a bit against the U.S. dollar since the September ECB statement.

Moreover, the ECB’s Staff Forecasts assumed that EUR/USD will average around 1.3000 in 2017. But since the euro has been falling against the dollar since the September ECB statement, the average exchange rate (year-to-date) now stands at 1.1192, which is lower than that assumed in the ECB’s own forecasts.

It’s therefore unlikely that Draghi will try to talk down the euro.

But just because Draghi is less likely to sound worried about the euro, doesn’t automatically mean that he won’t talk about the euro.

And even if Draghi doesn’t talk smack about the euro, there’s still a chance that journalists may ask Draghi about the euro during the presser, so keep on your toes.

Final thoughts

The ECB is expected to maintain its current monetary policy. However, the ECB is also expected to announce future changes to its monetary policy, at least with regard to the ECB’s QE program. And this will likely be revealed during the ECB’s initial press statement.

And the expected change is a tapered extension. The general consensus is that the ECB will announce that it plans to slash its monthly asset purchases by half to €30 billion per month starting next year.

This will likely be welcomed by euro bulls, although if the stated amount is less than the expected €30 billion, then there’s a risk that the euro may react negatively as a knee-jerk reaction.

Of course, the worst case scenario for the euro is if the ECB will not announce any future changes to its monetary policy. But such a scenario is highly unlikely, given that the Euro Zone economy has been evolving as expected (or better), and given that the ECB’s QE program will already be ending by December.

Aside from the QE amount, market players will also likely be looking for forward guidance on the ECB’s QE program.

If the ECB maintains its current forward guidance (quoted below), especially the part about the ECB standing “ready to increase the programme in terms of size and/or duration,” then that will likely be viewed as a dovish taper, so expect some euro bears to come out of the woods, even if the ECB does announce a tapered extension.

“If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the programme in terms of size and/or duration.”

But if the ECB omits that forward guidance or changes it to hint at a future end to its QE program, then that will very likely be viewed favorably by euro bulls as a hawkish taper.

As for the euro, the ECB’s initial press statement rarely mentions the euro, so if the euro is to be brought up, then that will very likely be during the ECB presser. Although Draghi is unlikely to try and talk down the euro, given the euro’s recent depreciation against the Greenback. There’s no guarantee that Draghi will not try to jawbone the euro, however, so just be careful.

By the way, if you want to watch the ECB presser live so that you can react in real time to what the Draghster has to say, you can do just that by clicking here.