DAX: Will a dovish ECB trigger EU stocks rally?

The key focus will be on hints about the prospects of an early tapering of the QE stimulus programme. If Draghi dismisses that possibility, which is more likely given that the ECB had recently shrugged off the pickup in inflation on temporary factors, then the prospects of low rates for longer could boost the European stock markets, and possibly undermine the euro.

The euro and equity markets have had a strong week so far, thanks mainly to a market-friendly outcome of the French first round presidential election at the weekend. The news caused the single currency to gap higher across the board and although gaps typically get filled quickly this hasn't been the case for the major euro crosses thus far, although the EUR/GBP is taking another bite out of its gap as I write. The stock markets in Europe also sighed relief as fears about the future of the European Union receded. Among Europe's major stock indices, the German DAX index caught the attention as it not only gapped higher but it also broke the previous record high set in April 2015. European investors will put politics on the back burner today and focus on economics. The European Central Bank is set to deliver its latest policy decision, a decision which will probably come as no surprise to anyone. The ECB is widely expected to hold interest rates and QE unchanged. It is therefore up to ECB President Mario Draghi whether we will see any sharp moves in the European stock markets and/or the single currency when he speaks at the press conference. The key focus will be on hints about the prospects of an early tapering of the QE stimulus programme. If he dismisses that possibility, which is more likely given that the ECB had recently shrugged off the pickup in inflation on temporary factors, then the prospects of low rates for longer could boost the European stock markets, and possibly undermine the euro. However, if he comes across as more hawkish than expected then we may see these markets move in the opposite direction: euro up and stocks down.

As mentioned, the German DAX has broken out above the previous record high level of 12390 and short-term resistance at 12375. This 12375-90 range may now turn into support upon re-test, possibly as early as today, potentially leading to further gains in the days and weeks to come. As we are at unchartered territories, this is where Fibonacci extension levels come handy to provide us objective bullish targets. The Fibonacci extension levels of the most recent corrective downswing come in at 12493 (127.2%), 12643 (161.8%) and 13077 (261.8%).  The 127.2% extension of the downswing from 2015 is at 13395. So, there is a possibility we may see further sharp gains. However, given that the weekend gap hasn’t been filled yet, we will be very quick to drop our bullish bias in the event that the index fails to bounce and hold above the 12375-90 range. In this potential scenario, could see sharp falls at least in the short-term towards supports at 12290, 12162 and 12092.

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