ECB Preview: Draghin’ his feet on future of QE could boost EUR

<p>On Thursday 20th October, the ECB will announce its latest policy decision. No change is expected, the market expects interest rates to remain at -0.4%, […]</p>

On Thursday 20th October, the ECB will announce its latest policy decision. No change is expected, the market expects interest rates to remain at -0.4%, and the Bank’s asset purchase programme at EUR 80bn per month. Of more interest to the markets is likely to be ECB President Draghi’s press conference at 1330 BST.

Traders will be looking to Draghi for two things: firstly, if he will confirm or deny unsubstantiated comments that the Bank is looking at tapering its asset purchase plan before its expiry in March 2017; and secondly, if the Bank will do anything extra to support growth when inflation is showing small signs of picking up.

Draghi settles markets’ taper tantrum

We believe that Draghi is likely to deny that the Bank will taper its asset purchase programme early. This week’s ECB bank lending survey showed that corporate and domestic lending is picking up within the Eurozone, and one of the key reasons is because loans are easier to access and the cost of financing them is low. We believe that Draghi and co. will want to continue to see lending growth, which is why they may need to keep, and potentially even extend, their current asset purchase programme.

This is also why market consensus seems to favour an extension of the ECB’s asset purchase programme when it expires in March next year. However, the Bank may not make a decision about its asset purchase scheme until its December meeting.

Rising expectations of a 2017 rate cut

The market expects no change to interest rates at this meeting. However, there are growing expectations of a rate cut in the coming months. Market based expectations for a rate cut in January have increased in recent days to 28% from 26% last week, by June next year the probability of a rate cut is up to 40%.

EUR and Banking stocks at risk from the ECB

This is important for the EUR, as rising expectations of a rate hike in the US in December, and falling expectations of a further rate cut from the UK now that inflation is rising, could make the euro the least attractive out of the main currencies. The single currency has held up relatively well until recently, before falling below 1.10 vs. the USD last week, it has also started to fall back vs. the GBP, EURGBP has fallen below 0.90 today as the UK government has started to soften its rhetoric around its Brexit strategy.

Overall, we believe that any dovish talk from Mario Draghi could be bad news for the EUR, and we may see acceleration in the single currency’s downtrend. In EURUSD 1.08 is a key level of support, while in EURGBP 0.8650 – the 50-day sma – is a key support level that the market may target on the back of a dovish Draghi.

Stocks in Europe have been trading in a tight range in recent months, and even if Draghi does sound dovish at his press conference on Thursday, we believe that European stocks may struggle to rally because of the impact of negative interest rates on Europe’s banking sector. Negative interest rates are considered bad for the banking sector, as it erodes their profitability. Thus, if Draghi does hint that further rate cuts are on the cards we could see further declines in Europe’s large banks including Deutsche Bank.



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