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ECB Preview: potential impact on the euro

This Thursday will be European Central Bank President Mario Draghi’s first monetary policy statement of the year. To say that it is much anticipated, would be an understatement; however, there is a very large possibility that investors could walk away from this event disappointed.

The background:

Following the release of the minutes from the last ECB meeting, investors had picked up on the idea that the ECB would potentially be changing its forward guidance early in 2018. The interpretation by some, given the eurozone’s robust economic recovery in 2017, was that the ECB had room to exit from the quantitative easing programme sooner rather than later. Therefore, the forward guidance would be adjusted possibly as soon as January, by removing the clause about extending if necessary, which had left the ECB room to manoeuvre by extending the quantitative easing programme if deemed appropriate.

The euro soared following the release of the minutes and has barely looked back since, on the understanding that this would then clear the way for the ECB forward guidance on monetary policy to begin to address the potential timing of the next interest rate rise.

Euro traders are clearly excited by the prospect of life after quantitative easing, which is helping to keep the euro at these elevated levels. But the strength of the euro has, in itself, created a headache for Draghi. The common currency has appreciated 15% over the past year and double digits on a trade weighted basis. Since the last ECB meeting, the euro has surged to its highest level versus the dollar in three years and in one session it experienced its biggest one day jump since 2014. ECB policy makers have already voiced concerns that the stronger euro could inhibit already weak inflation growth in the bloc.

What to expect:

With the reduced quantitative easing programme of €30 billion monthly purchases, having started just this month, we consider it unlikely that Draghi will change the forward guidance statement so soon. It is much more probable that Draghi will wait until March to make adjustments, when he has the new staff forecasts.

Draghi is likely set the path for changes to forward guidance, by highlighting that any changes to the forward guidance will only be gradual and that sequencing will not be altered. This final point will disappoint all those that are hoping for a rate rise by the end of 2018.

The recent appreciation of the euro, could bring us a more dovish sounding Draghi. We expect Draghi to push back against the strength in the common currency in the press conference, which could leave the euro vulnerable. However, we believe any pullback to be temporary, meaning that it could provide a good opportunity to buy into the euro.

Potential Reaction From the Euro:

EUR/USD is currently trading at fresh 3-year highs at $1.2350, as it trades at the upper end of its recent range. There is a strong support in the region of $1.2080, which we expect to contain any potential fallout and disappointment from this meeting, should Draghi look to talk the euro down in the Q&A session. On the other hand, should Draghi show that he is willing to tolerate some additional strength in the euro, then on the upside a meaningful break above $1.2350 could open the door towards the $1.25 region (high 17th December).

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