The European Central Bank ( ECB ) is in a 2-day meeting which will conclude during the 8/7 European session. The market is looking for signs pointing to whether the bank will implement further stimulus measures (QE). Chances are it won’t during this week’s monetary policy meeting. But the decline in inflation to an annual rate of 0.4% should put pressure on the bank. Let’s see how the bank addresses the disinflationary pressure and whether it will keep QE on the table.
The EUR/USD has been in a stead decline after consolidating in June. Price has fallen from 1.37 to 1.3333 today and shows no sign of reversal. The bullish divergence seen in the daily chart shows that the market is tentative ahead of the ECB decision. Let’s take a look at a few scenarios surrounding the ECB event risk.
(click to enlarge)
1) ECB Holds – Neutral Tone, with QE still on the table, but expectation of inflation to bottom out: The expectation is already biased toward a slightly dovish tone, so a slightly dovish tone like the previous meeting’s statement would be a essentially a neutral one. In this scenario, the EUR/USD still has downside risk toward the 1.3295-1.33 handle. If the market trades EUR/USD down to this level AFTER the ECB event risk, we can probably expect some support. If price indeed finds support at 1.33, we can then expect some consolidation with upside risk toward the 1.3475-1.35 area. However, if price is bullish around the ECB decision that ends up being neutral, then we should expect resistance from the falling trendline, with downside toward the 1.33 handle.
2) ECB is Dovish with increasing chance of QE – If the ECB focuses on the low inflation issue and hints at further stimulus measures in upcoming sessions, we should expect price to test and break the 1.33 handle. If it does, EUR/USD opens up the 1.31-1.3105 support level from Sept. 2013.
3) ECB is Hawkish, downplaying disinflation risk, and saying it will sit-and-wait. It might highlight risks of QE at this point. A hawkish tone would basically be a neutral tone that says “wait-and-see”. The difference will be very subtle, we can assess how the bank describes its concern for inflation. If it expects inflation to rebound, and expects economic data to recover, it is trying to avoid QE. In this scenario, we should expect the 1.33 handle to hold if price gets there. We should also expect a bullish outlook to test the 1.3475-1.35 area. This is a similar anticipation relative to the “neutral” scenario. The difference is if price goes to 1.35 and falls, traders are more likely to buy on the dip after the hawkish scenario.
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