There is an expectation that the ECB will wait it out until December to further intensify the dovish remarks regarding its currency’s role in restraining the inflationary pressures since the month of December is the most suitable month for budget rate cuts as compared to the prior two months.
Inflation is perceived to be excessively low as of the moment and the stability of the Eurozone market and several other macro metrics mean that the ECB can now afford to hold its ground until the release of its quarterly forecasts.
Recently, the EURUSD has been able to post its largest weekly low since July of 2012 despite fears that the ECB may possibly cut rates later this week. These apprehensions emerged after last week’s release of the Eurozone flash CPI which shows 0.7 % year-on-year, the lowest level in four years. Markets are already anticipating a 1.1 % and the minority of banks have changed their forecast expecting a cut from the ECB.
One way the ECB may cut its rates without necessarily dragging the deposit rate to below zero is to limit the refinancing rate and leaving a 0 % deposit rate. In this manner, the rate cut cannot be considered a done deal; however, the ECB may opt to restrain any renewed strengthening in the currency.
Before exploring the possible impact of the Euro, let us examine the differences between the conditions that prevailed in the in the early days of the first quarter this year when the single currency was able to hit 1 1/2 year highs before cascading down 7.0 %.
- The Eurozone inflation is at a 4-year low beginning at 0.7 % below the ECB projected 2.0 % level and was significantly way above the 1.8 % mark which prevailed the second quarter this year .
- Excess liquidity at the ECB stood at a 2-year low and the recall of the liquidity. If we recall the liquidity late last year, the banks began repaying the net proceeds from the ECB’s long term refinancing operations.
- The ECB may opt to consider giving a third LTRO to shore up the liquidity while back-up measures to stabilise inflation are not fully operational. Inflation may be at this moment extremely low, as well as the macroeconomic progress in the central nations as well as those along the periphery becoming much stronger.
The Euro Impact
The euro’s reaction on whether or not to cut the rate or refinance it to the extent to which the ECB will refer to the strength of the currency in the pre-conference statement as well as during the conference.
The drop in the deposit rate would somehow fuel most of the damaging effects on the euro, however a rate cut in the refinancing or lending rates would also burden on the currency as the base predicted to include no rate cut for the coming weeks to come.
A decision to maintain the rates unchanged would lead to a knee-jerk rally in the currency until the ECB chairman can jumpstart the press conference with particularly dovish commentary regarding the currency’s role in restraining the inflation pressures.
The recent month’s trend presently shows support at 1.3500 which will need a break later this week for the trend line to be considered as a breach. However, recoveries towards the 1.3500 level are seen as a momentary and short-lived position until the December meeting can take place.