ECB To Remain On Hold & Signal Further Stimulus To Come

Jul 20, 9:43 am

Wait & See Mode

With the rest of the G10 central banks choosing to remain on hold at this stage, the ECB are largely expected to follow suit tomorrow at their July rates meeting.  Instead, the focus of today’s meeting is likely to be on the UK’s decision to leave the EU and also the issues faced by the Italian banking system. Today’s meeting will also give the ECB an opportunity to comment on the progress of its TLTRO2 programme.

Risks From Brexit

Regarding the UK, the ECB is likely to highlight the downside risks posed to the growth and inflation outlook as a result of the UK’s decision to leave the EU though at this stage the fallout is not likely to be deemed severe enough to warrant immediate policy response. In the immediate aftermath of Brexit and without an appropriate level of incoming data to assess post-Brexit conditions the ECB is likely to follow in the footsteps of the BOE, opting to roll out any further measures at a later date such as the August or indeed, September meeting.  It will be precisely this signal of further easing ti come which will dominate the proceedings today with markets highly expectant that, following on from the reassurances given both before and immediately after Brexit, the ECB will look to ease in the coming months.

Market Expectations

The ECB knows only too well the cost of falling short of market expectations and are likely to give a firm indication today of the measures they will use to counter the economic damage caused by Brexit.  EUR positioning continues to build to the short side presenting the risk of a squeeze higher if Draghi fails to convince markets that the ECB has the “tools” to backstop the economy.

Given the high level of concern about the potential “unintended consequences” of negative rates on the financial sector it is more likely that the focus of these measures falls on the bank’s asset purchase programme.  Again, the data over the coming months will be key for the ECB in determining the correct policy response with the first, meaningful post-Brexit Eurozone data set to hit the wires after the ECB meetings, specifically German, French and Eurozone flash PMIs on 22nd July, German Ifo business climate index on July25th. German Unemployment rate & CPI on July 28th and French GDP, Eurozone Unemployment rate, July CPI and 2Q GDP on July 29th. EuroZone CPI will be especially key given the recent improvement in both headline and core readings which has seen the headline figure moving out of negative territory.

euinflation

An extension of the current QE programme beyond March 2017 now seems likely. The ECB issues updates of it staff macroeconomic projections for 2016-18 at the September 8th and December 8th meetings, indicating that should the data point to a severe enough deterioration in EuroZone economic activity over the summer then the September meeting is likely to be  the date that the ECB announces new policy measures.

ECB Running Out Of Bonds?

One important questions that many market participants are asking is whether the ECB will be able to find enough German bonds for purchase to continue meeting their target of E80bln a month.  To be considered for purchase in the PSPP, public sector bonds need to meet a set of criteria and with the yield of German Govt bonds up to 7rs maturity trading below the ECB’s deposit rate, a large section of German bonds are thus ineligible for purchase. As Germany received the highest volume of purchases and also the largest amount of bonds ineligible for purchase, markets are questioning whether the ECB might indeed run out of German bonds in the near future.

Consequently, we might see some technical adjustments made to the QE programme to help reedy this such as a removal of the deposit rate floor or a reduction in the deposit rate so as to increases the amount of eligible bonds.  Adjustments might also include an expansion of the range of assets available for purchase to include Bank bonds or a removal of the capital key allocation for PSPP purchases.

Data Flash

UK Unemployment came in at 4.9% in the 3 months to May beating expectations of 5% and marking the lowest level since October 2005. Average Weekly Earnings over the same period held steady at 2.3% whilst the ex-bonus figure fell back slightly to 2.2% from 2.3% and finally, LFS Employment +176k in the 3 months through May taking employment to a record high 31.705mio

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With over 6 years’ experience analysing currency markets, James is now a well-known industry analyst focusing on price action trading and fundamental drivers. Beginning as a private retail trader, James developed a strong interest in understanding the fundamental aspect of the market before pursuing technical trading capabilities which he now uses to identify opportunities over a short-term horizon. Alongside his market experience, James is also IMC certified having achieved the qualification to help further his understanding not only of the markets but the industry as a whole. James has a strong interest in both fundamentals and technicals and uses both forms of analysis in generating and executing trade ideas, with trades generally lasting from a few hours to a few days.

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