There has been growing speculation that the European Central Bank (ECB) is about to announce that it is prepared to provide more monetary stimulus to the Euro zone. Some analysts believe that this could happen as soon as this Thursday when ECB President Mario Draghi holds his scheduled press conference following the central bank’s rate decision. While the majority of market participants believe that the ECB will leave its current monthly bond purchase programme unchanged, many are nevertheless preparing for dovish comments from Mr Draghi, if not a commitment to ease monetary policy further by year-end.
It is worthwhile assessing current market thinking by considering the recent behaviour of the euro, particularly in relation to the US dollar. Certainly the EURUSD has pulled back from last week’s highs when it topped out just shy of 1.1500. This is consistent with the view that Mario Draghi will set a dovish tone during his press conference. However, it is also worth considering the currency pair in a wider context together with the US Federal Reserve’s own actions.
Back to the summer of 2014 the EURUSD was trading just shy of 1.4000. It then fell relentlessly until the middle of March this year when it bottomed out a touch under 1.0500. The initial sell-off was a result of speculation that the Fed was preparing to wind down the third phase of its quantitative easing programme. This was the bond-buying programme that it launched in September 2012, reaching $85 billion-per-month in asset purchases by December that year. It began to taper these twelve months later and finally wound up the programme in October 2014. This was dollar-positive and euro-negative. Adding to the downside pressure on the EURUSD was talk that the ECB was getting ready to announce its own programme of monthly bond purchases. The ECB finally pulled the trigger at the beginning of this year.
The EURUSD continued to fall as investors prepared themselves for the first US rate hike announcement since the Fed cut its headline rate to the 0 to 0.25% bound in December 2008. But its failure to move in March this year led to a sell-off in the greenback. As we now know, the US central bank has avoided biting the bullet ever since. The current thinking is that the Fed’s FOMC is unlikely to hike rates until sometime next year. This is despite hints from FOMC members that a December rise is still a possibility. There is another view that the Fed is, despite its rhetoric, unwilling to tighten monetary policy further. This is predicated on the belief that the US economic recovery is far from solid. Recent data supports this view while the Fed has also made it clear that it is concerned with the health of the rest of the global economy, China in particular. In addition, 2016 is election year and the argument goes that the Fed will not want to raise rates ahead of the Presidential vote in case it triggers a recession/stock market sell-off which could affect the outcome. If the Fed holds off, then the US dollar should (other things being equal) head lower.
Policymakers in both the US and Euro zone would like to see their currencies weaken. A weak currency makes exports cheaper so helps boost growth and also dampens deflationary pressures. Certainly US multinationals have been hit hard this year by the stronger dollar. But the Euro zone and the US can’t both have a weak currency at the same time. They have to take it in turns. As the US dollar (in euro terms) is currently up around 20% since June 2014, it would only seem fair that the euro should now take some of the heavy-lifting, at least temporarily.
But the Euro zone is bedevilled by low growth and deflationary pressures. It wants a cheap currency and economists (as well as many members of the ECB’s Governing Council) believe that there is room and good reason for more monetary stimulus. Whether it is announced at this meeting or not is another story.
The EURUSD is in an uptrend that began in March this year. But it continues to struggle to break and hold above a band of resistance which comes in around 1.1450/1.1500. The euro could pull back from here if the ECB and Mario Draghi are particularly dovish on Thursday. But if they’re not then the single currency could finally break out to the upside and add to its gains from the last six months. This would then set the scene for additional ECB stimulus to be announced at the end of this year.