ECB decision preview 8211 will Draghi trigger EUR USD declines

The European Central Bank will announce its latest interest rates decision tomorrow (7th August) at 12:45 PM (BST), but no one is expecting anything as spectacular as the package of measures the ECB unveiled in June.

• In an effort to stave off the threat of deflation and give signs of nascent growth a shot in the arm the central bank on Thursday 5th June unleashed an unprecedented package of measures:
• A new Targeted Long-Term Refinancing Operation (TLTRO) providing €400bn of cheap credit to euro-zone banks for lending to small firms
• Preparation for a new market for banks to bundle (securitise) loans to small firms
• Interest rate cuts–headline rate to 0.15%; rate for cash deposited by banks at ECB cut to a negative number -0.1%
• Stopped ‘sterilising’ sovereign bonds bought during 2011 and 2012. (‘Sterilisation’ is offsetting the effect of massive transactions on the market by selling or buying currency
• ‘Threat’ of further action if needed it, interpreted by many as more money printing (quantitative easing)

The EUR/USD pair’s reaction on the day was to initially jump to $1.363 from $1.36, before falling sharply to $1.355 and eventually trading as low as 1.3502.

Don’t expect a ‘big figure’ EUR/USD reaction to the ECB’s reaction tomorrow.

For one thing there are no major announcements left to make, after June and the further details in July.

However, it seems to make sense that the customary post-announcement Q&A (press conference) could yield some comments from President of the European Central Bank, Mario Draghi that could move the EUR/USD at least moderately lower.

This is what we expect Draghi to be asked:

1) Whether, in his view, euro-zone sovereign bond markets are in a bubble after another record low on 10-year Bund yields

2) His thoughts on inflation after the 0.4% lower-low print last week (though a formal inflation forecast is not scheduled in tomorrow’s announcements)

3) Whether credible bank asset-quality ratio/stress tests (announcements due in October) will produce more surprises, like Banco Espirito Santo.

On inflation, Draghi is likely to emphasise that we should wait for the June measures to take hold and point out that TLTROs have not started yet.

Regarding stress tests, Draghi has already stated banks do not need to fail in order to prove the credibility of the exercise. He’ll probably repeat this.

As for the currency, we do not rule out further declines in EUR/USD following the inevitable reporter question on currencies. Considering EUR/USD is 3 cents lower than the June 5^th decision, Draghi could well trigger further euro declines in the event that he expresses his approval with the euro’s latest trajectory.