ECB Preview: EUR/USD could suffer a drop but may experience a recovery afterward

There are so many things to like about the eurozone's improving prospects – raising expectations that can only end in disappointment when the European Central Bank announces its rate decision on June 10. However, any such dip will likely prove temporary due to several factors, Yohay Elam, an Analyst at FXStreet, briefs.

A disappointing outcome may weigh on the euro in the short term

“What can the ECB do in response to an improving outlook? Raising its interest rate is off the cards for the next few years, but it could taper down the pace of its bond buys. The ECB is deploying its Pandemic Emergency Purchase Program (PEPP), a relatively generous plan with few strings attached. Apart from reducing the rhythm, the bank could also announce that it would refrain from deploying PEPP in full. The current scope is a whopping €1.85 trillion that are expected to be completed.” 

“There are several reasons why the bank could disappoint cheerful investors and refrain from any tightening at this juncture. First, the emergence from the covid crisis is still fragile. If the Delta variant spreads quickly in the old continent, lockdowns or delays in easing could be on the cards, serving as a setback to the economy. Secondly, while headline inflation is at the bank's target, Core CPI remains tame, at 0.9% in May. Lagarde and her colleagues can see through the increase in energy prices and bumps related to the quick reopening and conclude that inflation is temporary. Therefore, a no-change decision is the most likely one, and it could weigh on the euro.”

“The main reason for EUR/USD to recover comes from the Fed and expectations of what it could do due to the increase in US consumer prices. At 12:30 GMT, just as Lagarde begins her press conference, the US publishes fresh CPI figures for May. Expectations are elevated and any headline figure that is under 5% could trigger a sell-off in the dollar. Another factor to consider is EUR/USD's tendency to undo its moves once the press conference ends and the dust settles. Such a reversion to the mean may also occur this time.”