ECB to pull out the stops on Thursday – should cap EUR’s recovery
As economies stagnate and deflation remains an ever potent threat, policy makers are increasingly running out of ideas, but with seemingly few other options, the European Central Bank is simply going to ramp up its existing stimulus efforts.
Look out for some fireworks on the EUR crosses this week. Expectations for action have been triggered by a shock plunge into deflation within the Eurozone with a -0.2% reading in February, which is woefully short of the +2.0% inflation target. This is why the ECB is expected to act.
Market chatter suggests the monthly quantitative easing programme could be stepped up by EUR 10bn-20bn on top of the existing EUR 60bn and / or extended and further reduce the deposit rate from -0.3% to -0.4%.
But there’s problem with negative interest rates. They’re crushing the margins of commercial banks. The idea is that by making them negative, banks will be forced to lend more rather than pay to have their cash held by the central bank. But in countries with negative interest rates that’s not really happening. Clearly, banks are struggling to find candidates to lend to given the higher capital requirements they have to meet and sluggish economic growth.
But negative interest rates do seem to be more effective when driving down the value of a currency, which the ECB is keen to do. However, the impact on the banking system – and some European banks are fragile at the moment – does need to be accounted for.
Therefore, they could do the following:
• Follow the Japanese lead and only apply negative interest rates on reserves above a certain threshold
• They may exclude some banks, such as smaller ones
• Look at other monetary instruments to spur bank lending to help offset negative rates
There may also be an issue with the QE programme. Some analysts suggest that there may not be enough bonds for the ECB to buy under their present criteria. They could of course widen the scope to get around that problem.
However, there is some tension within the ECB over how to do more stimulus – therefore there’s a risk that the announcement could underwhelm even though Mario Draghi seems determined to do whatever it takes to banish deflation from the shores of the Eurozone. If the ECB underwhelms the EUR is likely to move higher against USD.
Indeed, the next couple of weeks could be volatile. After the ECB’s Mar 10 meeting, it’s the Bank of Japan’s turn on Mar 15, followed by the US Federal Reserve’s FOMC meeting Mar 16 ending with the Bank of England on Mar 17.
Though no concrete action is expected from the BoJ, BoE and Fed, there’s always scope for surprises as they may say something to alter forward interest rate expectations for their respective currencies.
TECHNICAL ANALYSIS: EUR/USD vulnerable to sell-off if ECB disappoints
EUR/USD has been on something of a recovery over the last four daily trading sessions after testing lows of 1.0825 at the start of the month to then rebound to a recent high of 1.1045. Whether EUR/USD can decisively break-out of the boundaries set by that high and low now largely depends on what the ECB says at its press conference on Thursday.
The market is very much poised for the ECB to carry out more stimulus, and unless it departs dramatically from expectations, it could well reverse the recent recovery.
Support levels can be found around 1.0956, 1.0871, 1.0825 with long-term support at 1.0793. In terms of Fibonacci numbers, which could act as support are 1.0956 and 1.0859.
The biggest danger for EUR/USD is if the ECB underwhelms, which would likely propel the pair higher. It is already trading close to the seven-day high of 1.1045. Beyond that, further resistance can be clocked at 1.1107, 1.1128 and 1.1158. Fib numbers, which could act as a drag on any up-move include 1.1054 and ultimately 1.1376, which also a multi-month high.
Meanwhile, the slow stochastics generated a particularly strong buy signal on Mar 3, which could still have some scope to play out.
By Justin Pugsley, Markets Analyst, MahiFX