6 Things to Watch for from ECB March Meeting
Daily FX Market Roundup 03.09.16
Are you confused about why EURO is hovering near its March highs ahead of Thursday’s monetary policy meeting? Don’t worry you’re not alone.
The European Central Bank is one of the few major central banks still in the process of easing monetary policy, which is normally bearish for the currency. Not only is the ECB expected to lower interest rates but there are a number of additional steps that they could and will most likely take to boost inflation, add liquidity and spur growth. So if the ECB is expected to ease, why is the euro trading higher? An easy response would be to attribute the move to the central bank’s successful guidance. They’ve made their intention to ease abundantly clear and have given the market plenty of time to discount the move. However while investors and economists are in total agreement that a deposit rate cut will be announced, they are divided on the size of the reduction, increases to asset purchases, an extension to the QE program, more LTRO and Draghi’s forward guidance. In other words, we don’t believe that the market has fully priced in tomorrow’s announcement.
Instead, it is important to realize that the U.S. dollar is trading lower against most of major currencies today and not just the euro. Also, investors have been short euros for months and the uncertainty surrounding the ECB’s announcement has led some traders to close out their positions. We saw how EUR/USD verticalized after the central bank failed to impress in December and investors are worried the ECB could under deliver again. With that in mind, there are no less than 6 things to watch for at tomorrow’s ECB meeting and Mario Draghi’s press conference:
1. Size of Deposit Rate Cut – The ECB is widely expected to lower rates but anything more than 10bp reduction will trigger a knee jerk decline in EUR/USD. Also watch out for possible tiering of deposit rates
2. Extension of QE Program – In December, the ECB said they would extend their asset purchase program through March 2017. Pushing this date out by three to six months would not be a big leap
3. Adjusting the Size of QE – Increasing the amount of bonds purchased per month would be a more aggressive step. Anything from 10 to 20 billion euros would be negative for the currency (the larger the increase, the greater the decline) but if the central bank decides to leave QE purchases unchanged, expect a sharp and aggressive rally in EUR/USD.
4. New Long Term Repo Operation – If the ECB wanted to surprise the market they could also announce additional LTRO measures but they may forgo doing so if the deposit rate is reduced and QE purchases increased
5. Revisions to Staff Forecasts – We also expect the ECB to lower its inflation and growth forecasts after underlying inflation dropped to a 10 month low.
6. Mario Draghi’s Guidance – The future direction of the euro hinges largely on whether the central bank plans to ease after March. If Draghi simply says the door remains open to additional easing, we don’t expect a significant sell-off in the currency. Stronger rhetoric on the other hand could be very damaging for the euro.
The following table shows how the Eurozone economy performed since the last meeting. Aside from a 5 cent rise in the currency, inflation has fallen, while manufacturing and service sector activity weakened. Consumer spending and labor market conditions are mixed but improvements in that part of the economy won’t be enough to stop the ECB from easing. The only thing that the central bank can be truly be encouraged by is the recovery in oil prices which could go a log way in solving their low inflation concerns but it remains to be seen whether they believe that the turnaround in oil is here to stay.
Meanwhile the Reserve Bank of New Zealand surprised the market with a 25bp rate cut and a warning that further easing may be required. The decision to lower rates to 2.25% from 2.50% caught almost every economist and investor off guard and sent the currency spiraling lower. According to the monetary policy statement, the decision was motivated by low inflation as the central bank cut their 2016 Q1 annual inflation outlook from 1.2% to 0.4%. They also lowered their Q4 2016 annual inflation rate to 1.1% from 1.6%. The Reserve Bank now expects their 2% inflation target to be reached in the first quarter of 2018 vs. the fourth quarter of 2017. Domestic risks contributed to the decline in inflation expectations and their worry that prices will remain low for some time before recovery. China building and manufacturing sectors are also under significant stress creating a number of serious imbalances – they are clearly more worried about China than their Australian counterparts.
In contrast, the Canadian dollar traded sharply higher today after the Bank of Canada expressed very little concern about the strength of the currency. After leaving interest rates unchanged (which was widely expected), the BoC said the Canadian dollar and oil were averaging close to levels assumed in their Monetary Policy Report. Many investors were worried that despite the turnaround in oil and improvement in Canadian data, the BoC would focus on the 8.8% appreciation in the currency. Surely they would not want to send the loonie even higher. However instead of lamenting about the drag that a strong CAD would have on exports, the BoC suggested that everything is status quo with the near term outlook for Canada broadly the same as January and the U.S. expansion broadly on track. Inflation is evolving as anticipated while rate-sensitive energy exports are gaining momentum. USD/CAD dropped to a 4 month low following the monetary policy announcement with the move stopping right above the November 15th low near 1.3225.
The Australian dollar hit an 8-month high against the U.S. dollar despite softer economic data and lower commodity prices. Even as oil prices moved higher, the price of gold, copper and iron ore moved lower. Australian consumer confidence also declined in March while home loans and investment lending fell at a faster pace. The only explanation for the persistent strength of AUD is its yield. On the eve of another ECB rate cut, investors are valuing the steady 2% rate offered by Australia. The Reserve Bank has no immediate plans to lower rates and this high and steady return has made the Australian dollar extremely attractive. With that in mind, AUD/USD is finding resistance near 75 cents and may struggle to extend its gains in light of the RBNZ’s concern about China and recent double-digit declines in Chinese imports and exports.
With no major U.S. economic reports on the calendar, the recovery in Treasury yields and rise in U.S. stocks drove helped USD/JPY register its strongest day of gains since the first of the month. Although the rise in wholesale inventories and drop in wholesale trade sales is disappointing, next week will be a far more important week for the dollar.
Lastly better than expected U.K. data helped sterling avoided additional losses. U.K. industrial production rose 0.3% in the month of January compared to a 0.4% forecast. This lower headline reading was offset by the stronger year over year rise, upward revision to December figures and big upside surprise in manufacturing production.