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Greetings, forex friends! The ECB will be announcing its last monetary policy decision of the year this Thursday at 12:45 am GMT, with a presser shortly after at 1:30 pm GMT.

There’s therefore a 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 of what’s expected this time, then you better start reading 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 at reduced pace of €15B per month until December reaffirmed
  • Forward guidance that QE program will end after December reaffirmed
  • ECB still has hiking bias
  • ECB repeated forward guidance that rates ain’t moving “through the summer of 2019

As widely expected, the ECB announced no changes to its monetary policy during the October ECB statement.

All policy rates were therefore maintained while the ECB’s extended QE program will continue at a reduced pace of €15 billion per month.

The ECB also reaffirmed that its QE program will run until December 2018. And after December 2018, the ECB reaffirmed that “net purchases will then end.”

With regard to the future path of interest rates, the ECB maintained its hiking bias while also repeating its forward guidance that:

“The Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019.”

In short, the ECB statement didn’t offer any surprises, so the euro tossed and turned but the event was essentially a dud.

However, ECB President Draghi caused the euro to jump higher then broadly retreat during the ECB presser.

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

As for specifics, Draghi gave a positive assessment of the Euro Zone economy during his introductory statement. He also presented a generally positive outlook for the Euro Zone economy, adding that risks to the Euro Zone’s growth prospects remain “broadly balanced“.

Sentiment on the euro would sour later during the Q&A portion, however.

You see, there was a lot of concern surrounding Italy’s budget at the time since the E.U. rejected Italy’s budget just a few days before the ECB presser, which convinced investors to dump Italian bonds.

The market was therefore worried about a potential contagion to other Euro Zone bond markets. And Draghi was asked about the ECB’s view of a potential contagion.

And, well, Draghi didn’t really inspire confidence back then since he tried to deflect most Italy-related questions.

However, he did imply that there is a risk for contagion when he was asked about a recent speech and he clarified that:

“No, I didn’t say there wasn’t any risk of contagion; I said at that point in time there was no sign of contagion. It’s different.”

Draghi also warned that “the fact is that [the] monetary union remains fragile” partly because of developments in Italy.

Draghi was also asked about Brexit and he said that:

“I’m still confident that a good common-sense solution will be found where financial stability risks will be minimised”

However, Draghi quickly added that:

“I should also warn about another possibility. If this lack of outcome of solution will continue and will approach the end date, the private sector itself will have to prepare on the assumption that there will be a hard Brexit.”

Anyhow, those comment apparently dragged the euro lower. However, market analysts also later developed a narrative that the ECB’s tightening bias despite given the political and economic risks presented by Brexit and Italy is a bad idea, which likely weighed on the euro further.

What’s expected this time?

  • No change in policy rates expected
  • Forward guidance on rates will likely be maintained
  • ECB expected to announce end to QE
  • ECB may give some details on reinvestment plans
  • Growth forecasts likely to be downgraded
  • Inflation projections will also probably be downgraded

The general consensus is that the ECB will announce an end to its QE program while keeping rates on hold.

The ECB is also expected to maintain its forward guidance that key policy rates are to “remain at their present levels at least through the summer of 2019.”

And if the ECB does just that, then the ECB statement will likely be another dud.

However, if the ECB unexpectedly decides to prolong its QE program and/or changes its forward guidance to sound more reluctant to hike, then that will likely be bearish for the euro.

As for the ECB presser, that’s usually a market-mover, depending on what ECB President Mario Draghi has to say about the Euro Zone economy, monetary policy, and his overall tone and answers during the Q&A portion of the presser.

And if you didn’t know, there would be a link to a live stream of the presser here.

How is the Euro Zone economy faring lately?

The ECB will release its updated macroeconomic forecasts during the presser. But how does the Euro Zone economy hold up compared to the ECB’s September forecasts?

Source: September 2018 ECB staff macroeconomic projections
Source: September 2018 ECB staff macroeconomic projections
  • GDP for the whole Euro Zone only grew by 1.6% year-on-year in Q3 2018, so GDP growth is way off the ECB’s 2018 forecast of +2.0% by year-end.
  • The Euro Zone’s jobless rate came in at 8.1% as of October, which is beating the ECB’s forecast of 8.3% by year-end.
  • The flash estimate for headline HICP, meanwhile, came in at 2.0% year-on-year in November, which is well above the ECB’s median forecast of 1.7%.
  • HICP less energy, one of the ECB’s preferred measures for underlying inflation, came in at +1.2%, which is below the ECB’s forecast pf 1.3% by year-end.
  • HICP less energy and unprocessed food, another of the ECB’s preferred measures for underlying inflation, came in +1.1%, which is meeting the ECB’s forecast.

Given the above, it’s clear that economic growth deteriorated in Q3, so expect the ECB to downgrade its growth forecasts for 2018 and possibly beyond.

And while headline inflation is still beating the ECB’s forecast, one of the ECB’s measures for underlying inflation is lagging behind.

And taking into consideration the heavy losses that oil prices have been sustaining during the month of November, it’s highly probable that the ECB may also downgrade its inflation forecasts for 2018 and possibly 2019.

But if Draghi still says that risks to the outlook remain “broadly balanced,” then any bearish reaction to the downgrades will likely only be limited.

What’s expected of monetary policy?

Despite weak underlying inflation and the slowdown in the Euro Zone’s economic growth, Draghi said during his November 26 testimony before the European Parliament that (emphasis mine):

“Overall, recent developments confirm the Governing Council’s earlier assessments of the medium-term inflation outlook. The underlying strength of domestic demand and wages continues to support our confidence that the sustained convergence of inflation to our aim will proceed, and will be maintained even after a gradual winding down of our net purchases. The Governing Council therefore continues to anticipate that, subject to incoming data confirming our medium-term inflation outlook, net asset purchases will come to an end in December 2018.”

It’s therefore very likely that the ECB will push through with a widely expected announcement that the ECB’s QE program will finally come to an end.

And since an end to the QE program is widely expected, market players would therefore be sniffing around for clues on what the ECB plans to do with its balance sheet.

Remember, the QE program involves buying up lots and lots of bonds. And once those bonds mature, the ECB will either reinvest them by buying up more bonds in order to keep credit conditions relatively easy, or do what the Fed is doing and allow some bonds to mature.

And the base case scenario is that the ECB will repeat its mantra that:

“The Governing Council intends to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of the net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.”

In other words, the ECB will continue to reinvest and is not expected to start unloading its balance sheet yet, but it’s possible that the ECB may start giving some forward guidance on its plans for its balance sheet.

And if the ECB doesn’t do that, then it’s probable that Draghi will be asked about it during the Q&A portion of the presser.

As for interest rates, I already mentioned earlier that the consensus is that there will be no rate hike, but the ECB will keep the door open to a future rate hike while maintaining its forward guidance that rates are to “remain at their present levels at least through the summer of 2019.”

However, a December 5 Reuters report cited “five sources on or close to the ECB’s policymaking body” as claiming that “European Central Bank policymakers are debating ways to wean the euro zone off years of easy money, floating ideas such as a new kind of multi-year loans and staggered increases in interest rates.”

If those five sources are the real deal, then Draghi may offer some hints about the ECB’s future monetary policy plans during the presser. And if not, then it’s probable that Draghi will be asked about them.