EUR/USD Recovery Short-Lived, ECB Will Cut In December

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EUR/USD Recovery Short-Lived, ECB Will Cut In December

• The ECB last month raised the prospect of more monetary easing at its December 3 meeting to combat ultra-low inflation, which is at risk of undershooting the target of nearly 2% as far ahead as 2017 due to low commodity prices and weak growth.

• A rate cut aims to discourage banks from parking money at the central bank and start lending to generate growth. It can also weaken the currency as cash leaves the Eurozone in search of higher returns, boosting inflation as imports become more expensive.

• The ECB cut its deposit rate to -0.2% in September 2014 and said it could not go any lower. However, other central banks have cut further, including the Swiss and Danish central banks to -0.75%, showing that deeper cuts are possible.

• The debate is now about the size of the rate cut. The market expects a reduction by 10 basis points. However, the ECB used to deliver policy moves in excess of market expectations. For a largely bank based credit creation system in the Eurozone, it makes sense to focus on putting the liquidity to work as opposed to creating more excess liquidity.

• The risk in the cut is a squeeze on margins in the banking sector, already under pressure, and it is not clear that banks would boost lending to avoid the punitive rate for parking money with the central bank. Further complicating the matter is the ECB's earlier communication that the deposit rate was at lower bound so a cut would break the guidance putting some pressure on the bank's credibility.

• Although several Governing Council members have been critical of further policy easing, Germany's Bundesbank, a big initial opponent of quantitative easing, has been relatively quiet since the last ECB meeting. We should notice that a lower exchange rate supports German economy and probably that is why the Bundesbank is silent.

• Traders will eye comments from Bundesbank chief Jens Weidmann, one of hawks on the ECB governing council, as he speaks for the first time since the central bank hinted at more policy easing.

• European Central Bank's governing council member Erkki Liikanen, one of the most hawkish members, said the Eurozone inflation and growth prospects are facing downside risks, adding the ECB is “willing and able” to act to achieve its price growth target. His comments suggest a deposit rate cut is very likely.

• An aggressive deposit rate cut in December by the ECB at a time when the Fed is expected to start its own normalisation process should help to maintain a sell on rallies stance on the EUR/USD.

• Eric Rosengren, the dovish president of the Boston Fed, said the "very high" USD gives the Federal Reserve more impetus to raise interest rates only gradually. In his opinion the USD strength has been a problem for manufacturers looking to export overseas. But he said domestic demand should help offset strength in the USD and weakness among US trading partners, two factors that have kept inflation below the Fed's 2% target.

• We closed our EUR/USD long at the entry level of 1.0730, as the recovery was weak and short-lived and this would be too risky now to stay long or get long again. (Full Access - VIP Subscription Only)

Significant technical analysis' levels:

Resistance: 1.0880 (10-day ema), 1.0894 (high Nov 6), 1.0898 (high Nov 5)

Support: 1.0705 (low Nov 6), 1.0666 (low Apr 23), 1.0660 (low Apr 21)