ECB Preview: Can Drag Euro Lower?

The European Central Bank faces a difficult situation as it needs to decide whether to resort to a more monetary stimulus or whether to take smaller steps to address the current risks. The euro was one of the best performing currencies, up 8% against the dollar so far while it recovered 14% from its March lows. The rally in the euro was despite lower bond yields across the block.

This is in addition to the recent closures due to the increase in Coronavirus cases and vague Brexit, all this constitutes pressure on economic growth in the last quarter of the year and may extend to the first half of 2021.

The bank is expected to increase ECB’s Pandemic Emergency Purchase Program (PEPP) by another 500 billion euros, bringing the total to 1.85 billion euros. This should keep yields in the bloc under control despite the high levels of debt. The bank is also likely to expand its Targeted Long-Term Refinancing Operation (TLTRO) programs, which facilitate bank lending, and usually have little effect on markets. 

The European Central Bank is expected to keep financing terms loose but not sufficient to meet the requirements for an inflation goal of 2%, blaming the strong euro.

The market has already priced an increase of 500 billion to Pandemic Emergency Purchase Program (PEPP) and will not limit the currency’s strength, but the only factor that may really affect is a surprise cut in the deposit rate, along with an additional 500 billion euros to the emergency asset purchase program, but the chances of this happening are very low as the hawks of ECB will not stand idly by in the face of such measures but EUR/USD has room to fall if Lagarde warns about the exchange rate and especially if she hints at cutting rates.

Monetary policy alone will not be a solution to increase inflation to the target, and comprehensive fiscal measures are needed.

The euro bounced against the US dollar from the 1.21 level ahead of the European Central Bank meeting and the bank may make some moves but it will leave interest rates unchanged and thus the pair may see some correction after the massive sell-off earlier this week. In any case, the price started to rebound again and rose from its lowest level at 1.2058.