• Joel

EUR Risk Ahead: ECB Rate Decision Incoming

At 1245BST/0745EDT on tomorrow (Thursday) we have the latest rate decision from the ECB. 

No changes in policy are expected at this meeting on the rates, QE or refinancing operations front, as the ECB takes a breather following a big policy change at last month’s meeting. As a reminder, the ECB upped the size of the PEPP (its Covid-19 emergency QE programme) to EUR 1.35trln from EUR 750bln.

In terms of recent data; Eurozone confidence/survey indicators generally point to an improvement in the economic recovery since the last meeting, but “we are not out of the woods yet” says Danske Bank. They expect the ECB to strike a cautiously optimistic tone, based on the notion that the recession may turn out somewhat milder than the ECB had projected back in June, but still constitutes quite a serious drop in growth. Meanwhile, the inflation outlook has also hardly changed since the June meeting; high unemployment, increased uncertainty and the risk of companies going out of business is clearly still disinflationary, so Danske Bank think we will not be seeing anything close to the ECB declaring victory. 

Note, however, that though the tone of this meeting is likely to be cautiously optimistic, the verdict on the Eurozone’s economic recovery in May and June is still out as a lot of the “hard data” (like jobs data, industrial production and GDP) is missing from the picture. We should be getting much more of the data for May and June over the coming weeks, which will be important in ECB decision making in the second half of the year.

On a slightly different note; in recent weeks, various governing council members (the more hawkish ones such as Schnabel, Villeroy and Knot) have said that the ECB might not need to use the full EUR 1.35trln PEPP envelope (in other words, they have room to buy EUR 1.35trln in assets, but they might not need to if market functioning continues to improve/rates stay low). Furthermore, Schnabel said that a further expansion of the PEPP may not be needed. Many analysts, therefore, expect the ECB to reiterate this line of thinking (that the full PEPP might not be needed). 

But to assume already that the PEPP will not be needed in full would be premature thinking, argue ING. As noted above, the economic outlook is still uncertain and we are yet to get many of the most important data points for May and June. Moreover, “the negotiations (and eventual decision) on the European Recovery Fund will also have an impact on bond yields. An agreement next week should stabilize bond yields. Disagreement and postponement could add new pressure on peripheral yields” notes the bank.

In terms of the EUR reaction at tomorrow's meeting, “a more upbeat tone should help keep EURUSD elevated for an FX market already in the mood to sell USDs” says TD Securities. That said, this week’s ECB meeting is not seen as the main event for EUR, rather EU27 negotiations on the EU recovery fund are. Despite recent commentary from EU officials to suggest that big divisions remain, many analysts remain optimistic that further progress can be made on the deal this weekend. 

Indeed, ING argues that “European leaders have come already a long way on some very sensitive issues” and “the fact that there now is broad agreement about support for the worst-hit countries in the crisis and that there should be European borrowing from the market is already an enormous game-changer”.

“If an agreement on basic principles of a deal is found”, the bank continues, “that would be received very positively by financial markets, which have already responded positively in the run-up to a possible agreement”. In other words, EUR would rally BIG. On the other hand, ING argue that “if no deal is reached at the summit, this is not necessarily a disappointment” as there will be more time to negotiate over the summer. Sources have hinted that if a deal cannot be reached this weekend, there could be another EU Council Summit towards the end of the month. 



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