EUR/USD: Target Raised To 1.0940

EUR/USD firms ahead of ECB

• We expect the ECB to announce a six-month extension of its quantitative easing programme beyond March 2017 at the present pace of EUR 80 billion per month (interest rate announcement: 12:45 GMT; press conference: 13:30 GMT). The decision to keep buying assets at an unchanged pace would largely be intended to preserve the current “very substantial degree” of monetary accommodation, at a time when core inflation suggests limited progress towards a “sustained adjustment in the path of inflation consistent with the Governing Council’s inflation aim”. Following the recent back-up in long-term yields, scarcity has become less of an issue for the ECB. However, we still predict an increase of the ISIN limit up to 50% (from 33%) and a switch to a more flexible definition of the deposit-rate floor, applying it to a portfolio of bonds rather than to each individual security. The combination of these two measures would increase the ECB’s flexibility and make it easier for the central bank to continue the program at the current pace until around the end of 2017 even if long-term German yields were to fall back towards zero. Higher yields in the core countries, together with some spread widening in the periphery, have significantly reduced the likelihood that the ECB will announce any politically controversial recalibration of the capital keys at this stage.

• ECB President Mario Draghi is expected to argue that premature tapering - or slowly ending - bond-buying could abort a still timid recovery, unravelling the impact of the buys.

• ECB's fresh economic forecasts will be broadly unchanged from three months ago and the projection for core inflation is likely to be cut.

• The general economic outlook is not so bad and the ECB may start to think about removing stimulus soon. Inflation, which has been dangerously low, is now at a more than 2 year high and rising, with higher oil prices and predictions for more U.S. budget spending bolstering expectations. Euro zone economic growth is shrugging off Britain's decision to leave the European Union, and Germany, the bloc's growth engine, seems to be picking up speed again.

• We stay EUR/USD long, but the scale of the move depends on the ECB statement. We have raised the target to 1.0940. Technical analysis supports our bullish view. Long tail on Monday’s large candlestick signals a massive rejection of the downside.

 

USD/CAD: Less dovish than expected statement from Bank of Canada

• The Bank of Canada kept interest rates unchanged yesterday, as widely expected. Dropping its usual language about the balance of risks, the Bank of Canada said the current state of monetary policy "remains appropriate.”

• The bank moved away from a more pessimistic tone it set in October, when Governor Stephen Poloz said policymakers had actively considered cutting rates.

• The bank said more moderate growth is expected after a rebound in the third quarter, and said business investment and non-energy goods exports continue to disappoint. The bank also suggested recent job growth masks weakness in the economy.

• The bank noted the rapid backup in global bond yields since the U.S. election on November 8, which it said partly reflected market anticipation that spending by the Trump administration could drive rapid growth in an economy that is already near full capacity. Canadian yields have risen significantly alongside, the bank noted.

• The central bank pointed to a "significant" amount of slack in the Canadian economy , but also used language suggesting a rate cut is off the table as global growth picks up.

• The CAD strengthened against the USD on Wednesday as the Bank of Canada's rate decision and statement gave investors no reason to interrupt a recent appreciation. The gains came even as prices for oil, a major Canadian export, slid on bearish U.S. petroleum inventory data and doubts that production cuts promised by OPEC and Russia would be deep enough to end a supply overhang that has weighed on markets for more than two years.

• Our short-term USD/CAD short is close to its target now.

 

NZD/USD: RBNZ will keep rates on hold for some time

• The Reserve Bank of New Zealand said that its main interest rate is likely to remain at its current level for some time, though there were signs that super-easy policies globally were finally turning the corner. RBNZ governor Graeme Wheeler said in a speech published on the bank's website that its official cash rate projections were still "highly conditional" on assumptions around the exchange rate, migration and house price inflation.

• The central bank cut its main rate in November to a record low of 1.75% in an attempt to boost tepid inflation and signalled that it would not be reducing it further.

• The bank said the low point for CPI inflation had probably past and, helped by the improvement in global commodity prices, the bank expected December data to show that annual inflation was back within its target range of 1 to 3%. Wheeler noted the bank's stimulus efforts had been hampered by the extreme policy easings seen across the developed world, which had kept the New Zealand dollar uncomfortably high.

• Wheeler added that the recent powerful earthquake in Kaikoura was expected to deliver a burst in construction activity and add to costs in the sector, but had not changed the outlook for steady policy.

• The NZD was the biggest gainer among major currencies on Thursday. Our NZD/USD outlook remains bullish.