Euro To Fall As ECB Preps For More Easing
ECB To Cut Rates By 10bp In March But EUR/USD Still Set To Go Higher - Danske We expect the ECB to cut the deposit rate by an additional 10bp at the meeting in March while continuing with today’s reintroduction of its forward guidance that key policy rates will “remain at present or lower levels for an extended period of time”.
Over the next 6 months we look for a continued dovish ECB as headline inflation will head lower due to the base effects from the oil price decline. Hence, we expect for an additional extension of the QE programme on a 6-12m horizon.
The meeting today showed, the very low oil price and the risk of second-round effects are much more important to the ECB compared to the outlook for a tightening labour market, which eventually should put upward pressure on wages.
FX implications: EUR/USD still projected to go higher. With Draghi clearly hinting that the ECB could be first to ease among the major central banks following the latest market turmoil EUR/USD fell below 1.08. While we were surprised by Draghi's rather dovish stance, we maintain that EUR/USD is caught in the 1.05-1.10 range near term and still project the cross at 1.06 in 1-3M: another 10bp cut is already priced, and a QE extension further out should not prove a major drag on EUR crosses given still stretched positioning short the single currency.
Notably, Fed has also been repriced recently in a more dovish direction (only one cut now priced this year) but without much effect on EUR/USD as a range of counteracting forces are keeping the cross afloat at present. Rather than ECB easing we stress that a key risk to our call for limited EUR/USD downside is that Fed will continue with rate hikes with a reference to the continued strength in US job creation while ECB stays in easing mode beyond H1. We still expect EUR/USD to go higher on 6-12m horizon A weaker CNY and USD will be negative to euro inflation.
How Will EUR/USD Behave Into ECB March Meeting? - Goldman Sachs In our view, the market narrative on Euro zone inflation is too focused on global developments, like the renewed drop in oil prices. After all, month-over-month core HICP inflation, which excludes oil prices, would have to double relative to its pace in 2015 just to meet the ECB’s modest forecast of 1.3 percent this year.
This underscores that low inflation in the Euro zone has a heavy idiosyncratic, or Euro-specific, component, which is that real GDP has yet to surpass its 2008 peak (Exhibit 3), such that the output gap is likely above the consensus 2-3 percent estimate, and that ongoing structural reforms on the periphery may have shifted down the Phillips curve (Exhibit 4). As painful as the December disappointment was for us and many others, it is important to remember this underlying backdrop, which in our view means that the will be more easing for longer than the market expects. This is the underlying reason why we think the EUR/$ downtrend will continue and be large.
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The biggest story in the Thursday's foreign-exchange market was ECB President Mario Draghi’s surprisingly dovish comments on monetary policy. Many economists believed he would avoid making specific comments about more policy action but as we pointed out in yesterday’s note, the 3-cent rise in the euro and decline in oil prices since December encourages the ECB head to be characteristically dovish. But on Thursday he went one step further by saying that the central bank “will possibly reconsider its policy stance in March.” Draghi could not be any clearer in suggesting that they may increase stimulus at the next meeting (there is no meeting in February) and for this reason we believe the euro should trade lower. He said the ECB has the power, determination and willingness to act with plenty of instrument at their disposal. Even though economic activity improved in December, recent market developments give the central bank many causes for concern. The ECB is worried about the volatility in commodity markets, the geopolitical landscape and the slowdown in emerging markets. Oil prices are 40% lower than when they last released their economic projections -- and that decline puts inflation at very low and even negative levels according to Draghi.
We see a 90% chance of ECB easing in March. Draghi’s desire to be “vigilant” on the risks of a downward price spiral and his resistance to “surrendering to global factors” tell us that the central bank doesn’t want to be caught behind the curve. That 10% chance of no change will only occur if oil prices suddenly rocket higher or China sweeps in with a major stimulus program that turns risk appetite and the markets around. Of course, how much easing the central bank offers is up in the air. In December they under-delivered when they failed to lower the deposit rate and increase the amount of bonds purchased -- the 2 obvious options they could employ in March. From now until March 10, the euro will be a 'sell on rallies'.
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