Growth in focus for the ECBWhereas last month’s meeting was chiefly concerned with stabilising sovereign credit markets, this month the deteriorating growth picture is likely to be the focus of Mario Draghi and the governing council. The latest PMI survey readings for the currency bloc showed that the economy remains in contractionary territory and the PMI readings from the last three months suggest that the Eurozone economy may have contracted by approximately 1% over the third quarter.
Wait and see modeThere is some speculation that the ECB may cut interest rates (currently at 0.75%) to boost growth at this meeting. However, we believe there is a low probability of this happening. Firstly, real interest rates (when adjusted for inflation) are in deep negative territory, which still hasn’t had a meaningful effect on the Eurozone economy. Secondly, September’s initial inflation reading rose to 2.7% from 2.6% in August, which may keep hawkish elements of the ECB on their guard about rising inflation pressures in the currency bloc. Added to this, the ECB pushed its monetary policy remit to its limit when it announced its OMT bond-buying programme last month and interest rate changes are considered the last of the Bank’s ammunition. Hence, it may not want to lower rates just yet and instead keep that as a card in its back pocket if growth does not pick up in the coming months. Due to the potential for stronger inflation in the coming months the ECB may decide not to reduce deposit rates below 0%, which is the rate that the ECB pays to banks to leave funds with them.
We don’t anticipate any change to collateral rules to make it easier for banks in troubled peripheral countries to access funds. The ECB already changed the rules and widened its collateral policy at last month’s meeting, so the governing council may decide to remain in wait-and-see mode this month to decide what impact this change has on banks’ fortunes before changing policy yet again.
Draghi and the mythical OMT programmeWhat might the ECB do this week? We will be looking out for two things. Firstly, if the ECB hints that a rate cut is possible next month. This will be determined by Draghi’s comments on the recent poor economic performance, especially in France and Germany, and also his outlook for growth in the coming months, which he may talk about during the press conference.
Secondly, we will be looking for is how comfortable the ECB is with the OMT since it has still not been activated. Draghi may elaborate very little on this. He said last month that the OMT will not be triggered unless a country embarks on an economic reform programme agreed with the IMF and EU authorities. Although Spain’s 2013 budget contained more than 40 economic reforms, Madrid still seems unwilling to commit to a bailout programme. This morning its finance minister did not rule out requesting for aid, but said that Madrid needed time to consider the consequences for Spain and its Eurozone peers.
Thus, we believe there is very little that Draghi can say regarding this programme. Since the Bundesbank voted against the OMT in the first place it is highly unlikely that Draghi would wade into the debate about the programme of conditionality that could be applied to Spain, or suggest that rules could be eased just to activate the programme.
The Bank of England holds fireThe Bank of England announces interest rates at 1200BST/ 0700 ET on Thursday 4th October. We don’t envisage any change to interest rates or asset purchases from the BOE as its latest round of QE does not expire until next month.
The BOE appears to be in wait-and-see mode as it tries to assess the impact of July’s fresh asset purchases and also the Funding-for-Lending programme it established with the government. We expect this month’s BOE meeting to have a neutral impact on sterling.
The impact on the marketsIf the ECB remains in cautious mode we believe this could weigh on the euro in the medium-term as the economy is weak yet the ECB is not doing anything to try and boost growth. In the short term we may see a bounce in EURUSD if the ECB does not cut rates on Thursday as there is some expectation of a rate cut. This may benefit EURAUD in particular, after the RBA cut Australia’s interest rates earlier this week. See below for the chart. After an initial bounce, if the ECB does not do anything we believe this may put mild downward pressure on EURUSD and it may test 1.2830 – the 200-day moving average and the base of its recent range - in the coming days.
If the ECB encourages Spain to apply for a bailout, or hints that an aid request from Madrid is imminent, then we may see the euro stage a broad-based rally as the market may cheer the activation of the OMT and the ECB becoming the lender-of-last resort for the currency bloc. This could help EURUSD get over the 1.30 handle and re-test the 1.3175 highs from the middle of September. We think this has a low probability of happening.
In the short-term we believe that this pair remains range bound between 1.2830 (the 200-day sma) and 1.2970 – Tuesday’s high. A break to the downside opens the door to 1.2700.
EURAUD: this pair could benefit if the ECB does not cut rates on Thursday. 1.2650 then 1.2710 and 1.2760 are near term resistance levels. Any pullbacks towards 1.2580 may fuel buying interest as we lead up to the ECB meeting.
Chart: EURAUD daily