FX Daily: ECB unlikely to revive EUR/USD volatility

We see little scope for any surprise at the European Central Bank meeting today, and the options market is mirroring this view.

USD: Sidelined

Uncertainty related to the Chinese coronavirus has put pressure on risk assets after a travel ban was placed on the Chinese city of Wuhan, where the outbreak originated. While choppy risk appetite is the underlying narrative in global markets (with Asian assets bearing the brunt of this), regional stories have taken over and will continue to drive markets today. The Australian dollar rose after encouraging employment data, while the European Central Bank (see below) and the Norges Bank (unlikely to surprise, as per our preview) will gather most attention today. The dollar remains on the sidelines with only the impeachment trial worth monitoring in the US (mostly from an election perspective, rather than for the risk of President Trump’s removal for office).

EUR: ECB to have limited FX impact

The ECB meeting should have limited implications for EUR/USD, in our view. The two key points in the Bank’s message should be that data suggests a pick-up in inflation, and the manufacturing cycle has bottomed out. However, most of the focus is likely to fall on the launch of the strategy review, specifically in relation to the duration (we think until year-end), and  who will participate in the process (EU Parliament, academic groups). Our economists think the review will eventually lead to a new definition of price stability of “around 2%” from "below, but close to, 2%". The meeting will also give markets another chance to assess ECB President Christine Lagarde’s communication style; her first months have been characterised by very balanced rhetoric. All in all, we see little scope for any surprises and the options market is mirroring this view, with event vol breakevens at 26 pips in EUR/USD, sizably lower than the historical average for an ECB meeting (although the number is also reflecting the general low volatility environment).

GBP: Cut expectations shifting to spring

Yesterday’s rally in sterling – prompted by better CBI business sentiment figures – confirmed the magnified sensitivity of the currency to data. The reduction in rate cut expectations has continued, as markets now price in a cut of just 13 basis points in January down from 17 basis points at the start of the week. As they await the pivotal PMI release on Friday, investors seem to be more convinced a cut will come in March or May. Today, the calendar is empty, and we may see sterling stabilise around its new levels.

NZD: Inflation to endorse RBNZ neutrality

As the fourth quarter New Zealand inflation report is released tonight, the consensus sees an acceleration to 1.8% (previously 1.5%) in the headline print, but our economics team thinks there is room for an upside surprise. The convergence towards the Reserve Bank of New Zealand's target mid-point (2%) should underpin our view that the Bank will refrain from cutting rates this year (10 basis points of easing by August are in the price). This should prove beneficial to the rate spread with Australia (we expect a Reserve Bank of Australia cut) and therefore keep pressure on AUD/NZD in coming months.