Analysts’ Pick: Will the ECB follow the Fed, BoC and BoE’s lead later today?
- ECB is likely to at minimum cut rates and signal future policy to be accommodative to the coronavirus crisis
- We expect some form of targeted measure from the ECB to support either small businesses or businesses most affected by the virus outbreak
- Euro will probably face downward pressure as a result, pulling the EUR/USD currency back lower after the greenback dipped last week.
The ECB looks set to cut rates later this evening at 8.45pm (GMT +8) to help stimulate the European economy as the coronavirus spread across the bloc at a rapid rate. But financial markets likely already expect a 10bp rate cut to the ECB's deposit rate, bringing the benchmark rate further away from 0% to -0.60%. Swaps implied probabilities show investors pricing in a 10bp rate cut later today, with another one later this year by the meeting in September.
Expectations for a rate cut surged in the past two weeks with emergency rate cuts from both the Fed and ECB
But a rate cut is unlikely to satisfy investors. The European economy is likely to experience a large hit as a result of the coronavirus. The ECB was more optimistic in its last monetary policy meeting although that is likely to change. In a statement by ECB President Christine Lagarde last Monday, it is implied that that the ECB may be introduce a form of targeted measure to help relief businesses and individuals that are affected by the coronavirus.
Economic data already signals a possible reversal in trends, implying that GDP may contract in Q1 2020
Possible ways that the ECB could do this is via low-cost loans that target either businesses that are heavily affected by the coronavirus or in general SMEs, as small businesses will likely be the most affected by the virus outbreak. The ECB can also introduce subsidies for sick workers who are paid hourly to keep relieve individuals who are the most affected by the virus. While the expected economic impact of the virus is not expected to be long-lasting, the absence of targeted measures will most likely increase the likelihood of a prolonged recession.
In addition, the shock to crude oil prices will put pressure on inflation expectations and subsequently inflation in the EU. The ECB is hence more likely to be inclined to keep price stability in check. We view that a 10bp rate cut will not be enough to support price stability in the bloc in light of the price war between Saudi Arabia and Russia. The ECB may increase its asset purchases by 10bn euro to alleviate the effects of the low oil prices, although this decision will likely be heavily debated among officials.
A sharp decline in oil prices should put some downward pressure on inflationary measures, as the two indexes are historically correlated
In addition, we expect the ECB to send a clear message to markets that it is ready to do more if needed, to meet financial market expectations of future support should it be appropriate. Coupled with Trump's announcement today calling for retractions for travellers from Europe for 30 days starting Friday at midnight in the US, the outlook for the euro is skewed to the downside. In line with our analysis above, we expect the euro to weaken against the dollar later today, possibly past 1.1253's level, representing a downside potential of roughly 0.50%. Upside risks for the EUR/USD pair comes more in the form of the dollar weakening against major currencies as cases of the virus increase within the US and consumer sentiment dampens within the country.
Demand for euro recently surged after the greenback weakened amid uncertainty of the coronavirus outbreak in the US. Euro bulls have taken control of the currency pair and are looking to continue its momentum to drive the dollar back to level before the December 2018 drop in US stock markets as a result of the trade war. But our outlook for the euro remains weak, especially as the ECB is expected to release a fairly large monetary stimulus package later today. RSI also shows that the EUR/USD currency pair is trading near overbought levels and has room to decline. If the ECB acts in line with our analysis, bears will likely get a boost later on the ECB’s statement, allowing EUR/USD to break the 23.6% Fibonacci extension level of 1.1253 to trade within the 0%-23.6% Fibonacci band.
Support: 1.1253 / 1.1213 / 1.1158
Resistance: 1.1350 / 1.1395 / 1.1428
EUR/USD Chart (H4)