The Risk Of Post ECB Euro Rally

Thursday’s European Central Bank monetary policy announcement is the most important event risk this week. The ECB is widely expected to ease monetary policy, making them one of the few central banks actively fighting COVID-19’s economic impact with fresh stimulus. Normally the prospect of new easing should be negative for a currency but investors bid EUR/USD sharply higher last month and there’s a serious risk of a post ECB euro rally.

When the central bank last met in late October, ECB President Lagarde said they are looking to recalibrate all instruments at their next policy meeting. She warned that a contraction can’t be ruled out for the fourth quarter and there’s “little doubt” that more stimulus is needed as they “will be looking at (recalibrating) everything.”

10 and one 10 us dollar bill

Image Source: Unsplash

With less than 24 hours to their announcement, we can expect the ECB to at minimum, raise their Pandemic Emergency Purchase Program by 400 to 600 billion and extend it to the end of 2021 and possibly even 2022. More asset purchases are likely as well but most economists are not looking for a rate cut.

Central banks consider a number of issues when deciding how to change monetary policy but the most important are usually inflation, unemployment, growth and the exchange rate. Inflation is running at a year over year rate of -0.3% which is very low. Price pressures are starting to move higher with gas prices rising to their highest level since March. In October, the ECB said risks are tilted to the downside but with the start of vaccine distribution, the outlook is brighter. There’s still a high degree of uncertainty (a word used by the Fed) but recent data hasn’t been terrible – in fact, there’s been more upside than downside surprises in Germany’s reports. The expectations component of the ZEW survey, factory orders and industrial production rose more than expected. A brighter economic outlook from the central bank could drive the currency sharply higher.

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