ECB Preview: Lagarde to open the door to action and weigh on the euro

Rising covid cases, fears of a double-dip recession and fear of deflation could push the European Central Bank (ECB) to action – either immediately or via a hint of stimulus in its next meeting. President Lagarde could announce a long-term change, cutting rates, or most likely, more bond-buying – and all could bring EUR/USD down, FXStreet’s Analyst Yohay Elam reports.

See – European Central Bank Preview: 14 major banks expectations

Key quotes

“Coronavirus cases are surging in Europe and have surpassed the US when adjusted for population. The rapid spread of the disease is deterring consumers even before authorities impose restrictions – and they are growingly doing so.”

“Not only consumers may shy away from buying, but also companies. Markit's preliminary purchasing managers' indexes for October have extended their slide, pointing to lower investment sentiment and growing fear. The composite index for the eurozone dropped under 50, indicating a shift from expansion to contraction – also alerting that the recovery may end abruptly. The German IFO Business Climate also dropped.”

“Even if the ECB focuses on its narrow inflation goal – 2% or close to 2% – it is missing big time. While the headline Consumer Price Index often fluctuates in response to swinging oil prices, core CPI has been relatively stable and even encouraging. That is no longer the case, as underlying inflation decelerated to 0.2% in the preliminary release for October.”

“If Lagarde lays the ground for allowing higher inflation, the euro could retreat. With current levels of consumer prices, markets would mostly see it as a theoretical exercise rather than an imminent policy change and only push the common currency gently lower.” 

“The ECB could also hint that a rate cut is coming. However, the bank has limited room to act. Its deposit rate stands at -0.50% and any deeper dive into negative territory would have little impact on the economy with some unnecessary pain for the banks.”

“In the previous Pandemic Emergency Purchase Program (PEPP) announcements, the euro advanced instead of falling. Will recent history repeat itself, turning an announcement of more bond-buying into a buy signal for the euro? Probably not. Governments are already acting, either by taking advantage of the rock-bottom borrowing costs or via the funds made available by the European Commission's ambitious relief plan. Investors will likely return to the old reaction function of selling a currency in response to printing more of it.”