ECB Preview: How Lagarde's debut December decision may drive EUR/USD higher, three scenarios

"Dovish Draghi drags EUR/USD lower" has been one of this analyst's favorite headlines – but there is a new boss in town. Christine Lagarde has taken over the European Central Bank's presidency from Mario Draghi and now makes her first decision.

As Managing Director of the International Monetary Fund, Lagarde often called on central banks enact accommodative monetary policies, including specifically the ECB. Moreover, Draghi even complained once that he does not hear the IMF telling the Federal Reserve what to do. 

Also, the outspoken French ex-politician has often painted a gloomy picture of the global economy, seeing the glass half empty. Lagarde is therefore seen as a dove – one who would not only prolong Draghi's dovish policies but also add stimulus of her own. 

The new president has inherited a divided Governing Council – which has seen public arguments after Draghi's moves in September. The Italian slashed the deposit rate to -0.50% and restarted the ECB's bond-buying scheme – or Quantitative Easing – at a pace of €20 billion per month. German and other central bankers from northern countries criticized this decision while doves came out to defend it. 

While Draghi increased his calls on governments to do more, he decided not to wait and acted to tackle falling inflation. 

Less-dovish Lagarde

Since taking office on November 1, Lagarde has been working on bringing together the Frankfurt-based institution. She has called for unity and took her colleagues to an off-site meeting. 

She seems first to want to listen to her peers and defuse tensions before making her mark – waiting with further dovish moves. If she refrains from adding more stimulus, the euro may rise. 

And that may be easier to do as inflation – Draghi's driver to open to act – has recently picked up. 

Headline Consumer Price Index (CPI) has advanced to 1% – still only half the ECB's 2% target, but above previous levels. Core CPI, which the bank has been paying more attention in recent years, is also rising. Underlying inflation has hit a high of 1.3% – matching May's high. Core prices have last surpassed this level in 2013.

The central bank bases its policies not only on past data but also on outlooks for the medium term. In its upcoming decision, ECB staff publishes new forecasts for inflation and growth. Downward revisions to 2020 projections may push Lagarde toward a worried, dovish tone.

However, the figures are unlikely to change materially.

Recent economic figures from France and Germany have beaten expectations. There is a higher chance that economists in Frankfurt will upgrade projections, rather than cut them. That will also allow Lagarde to strike a balanced tone – or even a cautiously optimistic one, appeasing the hawks.

Moreover, after Draghi's signature moves, there is no urge on Lagarde to do more – especially close to Christmas. The upcoming holidays may result in inactivity – nor hints of new moves. 

Here are three scenarios.

1) Unity and appeasing the hawks – Euro-positive

Given all the arguments above, the base case scenario is that Lagarde leans on a pick up in inflation and marginally better forecasts to paint a rosier picture. Lagarde, who previously served as France's finance minister, is considered a highly skilled politician. By seeing the glass half full, she would appease the hawks and bring them closer. She may need them in the future if the situation worsens. 

In this scenario, which has a high probability, EUR/USD has room to rise.

2) Not rocking the boat and promising to learn – Euro neutral

Lagarde may opt to play it safe and refrain from making any statements that markets may interpret as leaning in any direction. She may stress her short time on the job and that she is still learning. Trained as a lawyer, some have criticized her lack of economics background despite her long years at the helm of the IMF. By promising to learn, she may try to court critics and also avoid angering members on both sides of the hawk/dove divide. 

The chances are medium, and if this occurs, EUR/USD may chop around, but remain in familiar ranges after the dust settles. 

3) Open to new and dovish tools – Euro negative

Being new on the jobs means Lagarde may make unintended comments – despite her vast political experience. She may straightforwardly answer a question and expose her true dovish colors. The new president may even hint that new tools are on the cards – potentially triggering speculation that she may go even further than Draghi.

EUR/USD may drop sharply on such mishaps – but the chances are slim. 

Conclusion

While the ECB is unlikely to change its policy in its last event for 2019, Christine Lagarde's first decision may cause high volatility in EUR/USD. Upbeat figures and forecasts, as well as an attempt to appease the dissatisfied hawks, may push the euro higher. In the case of a balanced approach, the general trend will probably remain unchanged. And a surprisingly dovish stance may send the euro down.