What’s up, forex friends? The ECB Statement and presser is coming up tomorrow (Sept. 8, 11:45 pm GMT).
And if you’re planning to trade this top-tier event for the euro, then here are a few things to keep in mind.
1. The previous ECB decision
- ECB maintained refinancing rate at 0.00% as expected
- ECB maintained the marginal lending rate at 0.25% as expected
- ECB maintained deposit rate at -0.40% as expected
- ECB maintained the QE program at €80B per month as expected
As widely expected, the ECB announced that it was keeping its powder dry during the July 21 monetary policy decision. However, the ECB added a rather dovish statement in its, er, official press statement:
“The Governing Council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases.”
And with regard to its QE program, the ECB said that:
“[T]he monthly asset purchases of €80 billion are intended to run until the end of March 2017, or beyond, if necessary, and in any case until it sees a sustained adjustment in the path of inflation consistent with its inflation aim.”
As such, the usual relief rally on euro pairs didn’t materialize, and the ECB statement was essentially a dud.
There was a quick buying spree when ECB Overlord Draghi delivered his prepared speech during the presser, probably because he kept stressing the need for structural reforms and supportive fiscal policies from the Euro Zone governments. Also, Draghi had some rather upbeat statements, such as:
“Following the UK referendum on EU membership, our assessment is that euro area financial markets have weathered the spike in uncertainty and volatility with encouraging resilience.”
“Financing conditions remain highly supportive, which contributes to a strengthening in credit creation. They continue to support our baseline scenario of an ongoing economic recovery and an increase in inflation rates.”
However, demand for the euro evaporated when the Q&A portion rolled around, probably because Draghi admitted that Brexit-related downside risks to growth in the Euro Zone have materialized. Also, there were a lot of questions on the Italian banking crisis, which also likely dampened demand for the euro.
Overall, the ECB had a wait-and-see stance during the July meeting, but with a clear easing bias.
2. Lackluster Euro Zone economic data
Having already pumped a record €1 TRILLION worth of QE into the Euro Zone economy, the ECB still has very little to show for its efforts.
Q2 GDP growth in the Euro Zone, for instance, was rather disappointing since GDP only grew by 0.3% quarter-on-quarter and 1.6% year-on-year. Both growth rates are weaker relative to their respective Q1 readings of +0.6% quarter-on-quarter and +1.7% year-on-year.And while the ECB already expected a slowdown, the details of the GDP report showed that the positive contribution from trade due to the 1.1% jump in exports (+0.0% previous) was the main driver for quarter-on-quarter growth.
Meanwhile, consumer spending grew at a slower pace (+0.2% vs. 0.6% previous) and gross fixed investments stagnated (+0.4% previous). This is the opposite of the ECB’s expectation that exports will weaken, but consumption and investment will continue to support the Euro Zone economy, as revealed in the minutes for the July ECB meeting.
Moving on, the headline flash estimate for HICP in the Euro Zone came in at 0.2% year-on-year in August. This is slower than the expected 0.3% increase but matched the previous month’s reading.
Still, it’s far cry from the ECB’s 2.0% inflation target. Meanwhile, the core HICP reading took a hit, coming in at 0.8% and missing expectations that it will maintain last month’s 0.9% pace.
To make matters worse, Markit’s composite Euro Zone PMI reading dropped from 53.2 to a 19-month low of 52.9. And commentary from the PMI report noted that the lower reading was “mainly due to weaker economic growth in Germany, as output in the eurozone’s largest nation rose at the slowest pace for 15 months.”
Additional commentary from Markit’s Chief Economist, Chris Williamson, noted that:
“The survey data will fuel expectations that the ECB would prefer not to wait before injecting more stimulus into the economy, adding pressure for policymakers to act later this week to help shore up confidence in both the outlook for the economy and the bank’s commitment to its inflation target, even if simply by extending its QE programme.”
3. What do economists expect?
Markit’s Chris Williamson is not the only one expecting further stimulus. According to a Bloomberg survey of 50 economists, almost 50% think that we’ll be getting additional easing moves tomorrow.
In addition, almost 40% of the economists surveyed expect a tweak in the ECB’s QE rules. It’s therefore gonna be a close call, so the chance that euro pairs will get a volatility infusion is higher-than-average.
4. What can we expect from the ECB?
Okay, about half of economists expect the ECB to act tomorrow. But if the ECB were to act, what can we expect from the ECB? Below are the main tools available to the ECB.
Practically all economists surveyed expect another extension of the ECB’s QE program. You see, the ECB’s QE program was supposed to run until September of this year. However, inflation remained weak, so the ECB was forced to extend its QE program until March 2017 back in December 2015. And as I wrote earlier, inflation remains weak, even though the ECB’s extended QE program will already be ending in six months.
Again, practically all economists expect this from the ECB as a bare minimum, so this has likely been priced-in already and euro pairs are not expected to react from this, but I could be wrong.
Aside from extending its QE program, the ECB can also expand it. The ECB already expanded its QE program during the March ECB meeting by increasing its asset purchases from €60 billion to €80 billion a month while expanding its purchasable asset types to also include non-bank corporate bonds in addition to government bonds.
Only about 15% of economists expect an increase in monthly asset purchases while around 10% expect that the QE program will be applied to other asset types such as equities.
We will likely get a good bearish reaction from the euro if the ECB implements either of these two.
The ECB also slashed its rates across the board during the March meeting. And for the upcoming ECB decision, just over 30% of economists expect a deposit rate cut while around 15% expect a cut to the main refinancing rate. The marginal lending rate, meanwhile, is expected to hold steady.
Implementing any of these would also likely cause a bearish reaction for the euro.
Tweaks to the QE rules
I mentioned earlier that almost 40% of the economists surveyed expect a tweak in the ECB’s QE rules. Let me expound on that. You see, the ECB must comply with the 33% issue share limit. The issue share limit refers to the maximum share of particular security (bonds in this case) that the ECB is willing to hold.
The share limit exists as “a means to safeguard market functioning and price formation as well as to mitigate the risk of the ECB becoming a dominant creditor of euro-area government,” according to the ECB.
In plain English, the limit exists to prevent distorting the market, as well as to avoid violating the E.U. law against financing government deficits of member states.
There’s also something called the “capital key rule,” which refers to, well, the rule (I need to buy a thesaurus) that monthly asset purchases must be allocated between countries according to capital subscriptions by member states rather than their outstanding debt.
The problem now is that the ECB may run out of desirable bonds for its QE program, given that the Brexit referendum has apparently driven up demand for European bonds. And one of the easier ways to alleviate this problem is to tweak the aforementioned rules, especially if the ECB wants to extend and/or expand its QE program.
This potential shortage of bonds was brought up during the Q&A portion of the previous ECB presser. However, ECB Overlord Draghi avoided answering the question.
Keep an eye out for potential hints that the ECB may tweak its QE rules since that could be a sign that the ECB will be easing further down the road, which will likely trigger a reaction from the euro, even if the ECB decides to maintain its current monetary policy yet again.