Currency Briefing: ECB preview

on Dec 5, 2013
Updated: Oct 21, 2019
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No change in monetary policy is expected to come from the ECB meeting today, according to the central banks’ policy observers. Market participants will pay close attention to the ECB’s new growth and inflation projections, in addition to Mr. Draghi’s “forward guidance” on the need for more policy easing in the near term.

The Governing Council could try to intensify its rate guidance by publishing below-consensus, long-term projections for growth and inflation, according to analysts from Citi. The prospect for further ECB easing before long should keep headwinds for EUR in place for now, they added. Technicians express their view about more dovish sentiment in EUR/GBP, whereas the risks for a renewed move lower for EUR/USD could increase if the U.S. data surprises on the upside in coming days.

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With regards to growth projections, the current forecast of 1.0 per cent YoY for 2014 might be revised slightly to the downside given that the upward Eurozone sentiment indicators have recently lost momentum with PMIs in Southern Europe dipping below 50. In addition, the new 2015 growth projections’ figures could come well below the 1.4 per cent consensus estimate. Such an outcome would be consistent with the latest ECB monthly bulletin which stressed that the Eurozone potential growth has fallen sharply to 0.9 per cent in recent years.

With regards to inflation projections, recent escalating evidence of disinflation in the Eurozone indicates significant downside risks for the current 2014 Harmonized Index of Consumer Prices (HICP) projection of 1.3 per cent YoY. The 2015 inflation projection could fall below the current consensus view of 1.5 per cent as well with Citi economists expecting staff’s point estimate to come in just above 1.0 per cent. Given that, according to President’s Draghi, the November refi rate cut was assumed to oppose potential downside risks to the central bank’s inflation outlook in near-term, longer-term projections that accent on subdued price pressures could be seen as dovish. HICP projections could therefore be revised lower in the coming months.

The ECB could try to beef up forward guidance by providing more detail about the duration of the “extended period of lower rates.” One way to do this is to link the rate outlook to the long-term outlook for inflation. In particular, the Governing Council could release inflation projections for 2016 or beyond that, saying that it does not expect inflation to return to its target of “close to but below 2 per cent” any time soon. Worth highlighting in this regard is that the latest ECB monthly bulletin pointed out the Eurozone output gap grew to its widest level since the 2008-2009 global financial crisis.

With regards to more ECB measures, it’s crystal clear that investors will look for indications that the Governing council has at least debated more easing measures like another refi rate cut, negative deposit rates and long-term refinancing operations (LTROs). Just to recap, the refi rate is the price banks pay to borrow from the ECB. Of key importance would be potential signals that more easing may be needed given the long-term outlook for inflation and growth from here. In addition, President Draghi could emphasize the recent drift higher in the EONIA benchmark as time moves closer to an Asset Quality Review and stress tests and discuss the type of long-term refinancing program that the Governing council would implement should liquidity tensions escalate from here (but is the latter a possible scenario?). Last but not least, the ECB President has the power to mention the persistent strength of EUR and link it to the persisting disinflation in the Eurozone.
What would be the EUR outlook form the ECB decision and subsequent press-conference? Citi analysts conclude that the prospect for further easing should, of course, continue to limit EUR gains even if deteriorating market risk sentiment continues to support the single currency across the board.
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