Draghi to disappoint EUR/USD bears today?

Today the ECB will probably confirm its monetary policy stance and the most important parts of its communication, including its forward guidance on interest rates, QE and reinvestment. However, the meeting will not be uneventful as the sudden deterioration of growth indicators in the last couple of months raises uncertainty about the outlook.

Among Governing Council members, the prevailing interpretation is that the pace of growth has begun to normalize after strong acceleration until the end of last year. Therefore, the ECB will probably continue to regard risks to its baseline scenario for domestic activity as broadly balanced, while risks stemming from external factors will still be considered to be tilted to the downside, reflecting the threat of protectionism and the potential for unwelcome volatility in currency markets.

We expect the ECB to confirm its increased confidence that inflation will ultimately converge towards target, while sticking to prudence, patience and persistence in its monetary policy decisions as the CPI recovery will be slow and protracted. Uncertainty has increased overall, but we remain comfortable with our view that the ECB will terminate QE in December after a quick tapering, with the first increase in the deposit rate likely to come in mid-2019.

In light of how dovish the expectations for today’s ECB meeting have shaped up in the currency market, we see room for disappointment. Over the past few days, 1-week and 3-month risk reversals in EUR/USD went from around flat towards gearing up for a downward move in EUR/USD as a reaction to the ECB meeting outcome. This probably reflects expectations that the ECB will sound concerned about the weaker economic data of the past few months. However, we expect the ECB to keep its constructive baseline scenario, potentially acknowledging increased uncertainty around its central estimates, but maintaining the balance of risks broadly unchanged. In our view, this outcome may well fall short of the dovish expectations that the market has been gearing up for, and consequently, EUR/USD could come under significant upside pressure. Although the dollar has recently built momentum, from a medium-term perspective the picture remains EUR/USD bullish.