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ECB

As largely expected, the ECB left its monetary policy unchanged in its September monetary policy meeting, but that didn't prevent the EUR/USD pair from appreciating. Ahead of the announcement, the pair surged to 1.1992, its highest in two weeks, with the market holding its breath ahead of the press conference, as the ECB offered no hints of futures moves in the statement. The pair surged to 1.2058 during the press conference, as despite an extreme moderate and cautious tone, ECB's head, Mario Draghi ended up saying that they will discuss tapering in October. Growth projections were revised higher, while inflation ones were revised lower, both by little.

Last release reactions

CityIndex Team of Analysts

There is a good chance that the tapering process will be a much longer slower process than what the market maybe was hoping for.

Craig Erlam

The problem ECB faces is, in not talking about tapering or, more importantly, suggesting that the program could be extended as it is beyond the end of the year, they are effectively confirming that tapering will happen.

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ECB latest analysis

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Up for six months in-a-row and at its highest since January 2015, half of EUR/USD's rally has been based on dollar's weakness, but the other half has been the result of speculation that the ECB will trim its QE program this year. Speculation on the matter grew amid an optimistic Draghi and rising inflation, anyway still below the ECB's target of "close to, but below 2.0%." Encouraging growth figures, with manufacturing and services indexes steady at six year lows since the end of the first quarter, backed the case of less monetary facilities needed in Euro-land.

1. Price Scenarios
Key levels for major pairs on the upside and downside

2. What to expect this time?
Draghi to fight EUR/USD bulls, might kick the can down the road

3. What to expect in the future?
QE tapering expectations for ECB future upcoming meetings

1. Price Scenarios

  • To the downside, below the low of 1.1822, 1.1780 and 1.1740 are the next level to watch on persistent EUR's weakness over the following sessions.
  • A break below 129.18 [Gann fan line] would add credence to the bearish RSI and open doors for a sell-off to 127.56 [Aug 18 low]. An end of the day close below 127.56 would signal the rally from the April low of 114.85 has ended.
  • Bullish Scenario: A rebound from the Gann Fan line, followed by a break above 130.64 [Tuesday’s high] would open up upside towards the rising channel resistance of 132.40.

2. What to expect this time?

Context & info of the event - Draghi to fight EUR/USD bulls

ECB's head Draghi has sounded optimistic meeting after meeting, but warned about the risk of retrieving QE and cheered the positive effects it has in the economy. The market, however, ignored the cautious side of its speech, and rushed to price in upcoming tapering since last March, and even forced Draghi to set a date in the July meeting, when the press persistently asked and got his word that policymakers will discuss the issue "during the fall."

Draghi doesn’t want a stronger EUR, and there's little he could do about it, as his attempts to down talk the currency have been worthless.

The crucial question facing the ECB is whether Mario Draghi will announce the date of cutting bond purchases. The decision to taper asset purchases was widely expected to occur in today's meeting, after Mr. Draghi hinted on 20 July that the discussion on tapering assets should take place in Autumn. Since then, the Euro has appreciated by more than 4.8% against the dollar, but declined slightly after peaking at 1.2069.

Technically, the Autumn season starts towards the end of September, so even if Mr. Draghi decided to delay the announcement of tapering the asset purchase program, this wouldn't affect his credibility.

3. What to expect in the future?

Future events, QE tapering expectations

46 of 66 economists in a Reuters poll taken from August 28 to August 31 expect the central bank to announce a change in October. A couple of weeks back, more than half economists were calling for an announcement in September. As of now, only 15 economists expect the taper announcement tomorrow, while 5 economists expect it to come through in December.

Clearly, the expectations of QE taper have been pushed out from September to October. This explains the exhaustion in the EUR/USD pair near 1.20 levels.

How much will the ECB slow its purchases? A Reuters poll found most expect a cut to 40 bln euro from 60 bln euros. Since March the ECB slowed its purchases to 60 bln euros from 80 bln euros. However, and this is important, a cut to 40 bln euros for H1 18 would be a clear tell that its purchases will continue into H2. This would be part of a dovish tapering. We make the case that a cut to 30 bln euros would give officials the flexibility to stop in the middle of next year if it chose. A reduction to 30 bln euros a month would also take more pressure off the shortage of securities and the capital key.

 

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what is the ECB?

The European Central Bank is the central bank empowered to manage monetary policy for the Eurozone. With its beginnings in Germany 1998, the ECB is empowered to maintain price stability in the euro area, so that the euro’s purchasing power is not eroded by inflation. As an entity independent of individual EU countries and EU institutions, the ECB aims to ensure that the year-on-year increase in consumer prices is less than, but close to 2% over the medium term. Another of its tasks is the one of controlling the money supply. This involves, for example, setting interest rates throughout the euro area. The European Central Bank’s work is organized via the following decision-making bodies: the Executive Board, the Governing Council and the General Council. Mario Draghi, member of the Executive Board, is also the President of this organism. His speeches, statements and declarations are an important source of volatility, especially for the Euro and the currencies traded against the European currency. 

who is ECB's President?

Mario Draghi was born in 1947 in Rome, Italy. Graduated of the Massachusetts Institute of Technology, he became President of the European Central Bank in 2011. Draghi gives press conferences in the back of how he observes the current European economy. His comments may determine positive or negative trends for the Euro in the short-term. Usually, a hawkish outlook is seen as positive/bullish for the EUR, while a dovish one is seen as negative/bearish. 

Mario Draghi

Draghi on his Profile and Wikipedia

hike, low or mantain interest rates

The decision always has an effect on the Euro.

When the interest rate is increased the European Central Bank is literally selling government securities to large financial firms. In turn, the financial organizations are paying in Euros for these securities. This effectively decreases the amount of currency circulating in the economy. A decreasing supply leads to higher demand, and therefore causes the value of the Euro to appreciate.

When the interest rates are decreased, the European Central Bank floods the market with Euros. This is done by the purchasing government securities from financial organizations. In return for the securities, these banks and financial deals are paid in Euros, therefore increasing the supply of Euros in the economy. As supply increases, the value of the Euros depreciates.

the world interest rates table

The World Interest Rates Table reflects the current interest rates of the main countries around the world, set by their respective Central Banks. Rates typically reflect the health of individual economies, as in a perfect scenario, Central Banks tend to rise rates when the economy is growing and therefore instigate inflation.

How to Trade the ECB Rate Decision

Prior to the Rate Decision:

  • Many traders buy the rumors and square their positions shortly after the decision is made. For instance, if the market believes that the European Central Bank will hike the rate; traders buy the Euro and close the position shortly after the announcement. On the other hand, if the expectation is a rate decrease, traders will short the Euro and square the position after the announcement.

After the Rate Decision:

  • If the market’s expectations differ from the actual rate decision there can be some excellent trading opportunities.
  • If the market is expecting a rate hike, but the European Central Bank ends up cutting the interest rate, a short 1-2 hour trade selling the Euro may prove successful.
  • If the market expects a rate cut, but the ECB comes in with an increase in the rate, a trader may want to place a short long position on the Euro for 1-2 hours.

some concepts you need to know

In practical terms, QE means that central banks create money out of nothing to buy securities, such as government bonds. This new money swells the size of bank reserves by the quantity of assets purchased and that’s why this programme is called Quantitative Easings. The money supply is intended to flood financial institutions with capital in an effort to stimulate lending and increase liquidity.

Much of the governments’ debt is held by banks in the Eurozone and the ECB wants them to give more credits. If the European Central Bank buys government bonds, their prices rise and profitability drop even more. This is a liquidity-providing operation that weakens the value of the euro. This depreciation makes European exports cheaper and competitive, and ultimately, helps in recovering. In addition, as a result of the stimulus to internal and external consumption, the ECB combats the risk of deflation, a widespread and prolonged drop in prices, as well as the high unemployment.

The long term refinancing operation (LTRO) is a cheap loan scheme for European banks that was announced by the European Central Bank towards the end of 2011 in a bid to help ease the eurozone crisis.

Round one was carried out on 21 December, when banks took €489 billion from the European Central Bank. The loans are due to be repaid within three years at a rate of 1%, and a second round will be launched on 28 February, with the results of how much money was requested due on 29 February.

As the eurozone crisis has escalated, banks have become less stable and have less money to lend. The objective of the LTRO is to boost cash flow in the market and avoid a severe credit crunch or collapse of the banking system. 

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