Thursday, September 10, 2020

The ECB will probably keep its tools unchanged but may hint at further stimulus later in the year at today’s meeting

Tags
  • Dollar
  • Euro
  • European Central Bank

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Analysts’ Pick: The ECB will probably keep its tools unchanged but may hint at further stimulus later in the year at today’s meeting

  • The ECB will likely keep monetary policy on hold at its meeting today
  • A stalling economic recovery in the EU and a resurgence in Covid-19 infections in the bloc suggests that the ECB may have room to ease further at later meetings in the year
  • The euro will likely face downside as the ECB may hint of further stimulus in upcoming meetings
  • The dollar will probably continue to face downward pressure as headline unemployment benefit claims is likely continue to show an inaccurate picture of the labour market in the US

In the short-term, the outlook for the euro continues to look tilted towards the downside due to a stalling economic recovery and accelerating cases of Covid-19 infections in the country. Both factors should also contribute to the European Central Bank's outlook for monetary policy and the economy in the EU at its decision later today. As per our previous reports, cases in major economies in the bloc has shown signs of accelerating Covid-19 infections. Most concerning would be Spain and France, as both countries continues to show increasingly high positive rates, suggesting that they may not be testing wide enough to ensure that the current infection count is an accurate reflection of the total cases in the country. This should concern the ECB, since Covid-19 case figures for both countries are already reflecting these findings.

Covid-19 cases spiking in France and Spain remain the most worrying

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Positive rates in both Spain and France continues to climb

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At the ECB's last monetary policy meeting in July, the EU's economy was still experiencing a rebound in activity but higher frequency data compiled by Bloomberg now suggests that the recovery in the bloc peaked in August below pre-Covid-19 levels. While there are caveats to the data by Bloomberg (the high weightage of travel and mobility indicators may understate e-commerce spending, which has surged in the past few months), it does still give a good representation of overall economic activity and possibly signals an imbalanced recovery across sectors and member countries. This means that while today's meeting will probably result in no changes in the ECB's monetary policy tools, there may be room for the central bank to ease later this year - and consequently hint at the likelihood of that in today's monetary policy statement.

High frequency data shows peaking economic activity in EU member countries

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Traders today will also be focused on initial jobless claims data in the US, which will likely follow a recurring theme of continual improvements at a gradual pace. This will likely apply for headline figure in both initial and continuing claims. However, due to seasonal factor methodology changes as well as multiple states allowing only a maximum of 26 weeks’ worth of claims, the headline figure will likely understate the severity of unemployment in the US. Still, we view this to have a more delayed impact on financial markets, which would mean that in the immediate release of the data the dollar may suffer more downward pressure before recovering some losses later in the trading session.

Over the medium-term, stalled Brexit negotiations may likely put additional downward pressure on the euro when weighted against the dollar. Brexit negotiations between the UK and EU has stalled and looks likely to continue to stall moving forward. Most recently, British Prime Minister Boris Johnson's government published legislation on Wednesday allowing it to re-write parts of the Brexit Withdrawal deal that it signed with the EU last year. The key points of the legislation, the Internal Market Bill, will give the UK the power to waive customs paperwork on trade crossing between Northern Ireland and Great Britain as well as unilaterally define which goods entering Northern Ireland will be liable for tariff in the event of a hard Brexit. The bill would also allow the UK to shut down any EU state aid rules contained in the Northern Ireland protocol in the Brexit Withdrawal Agreement. Be it a safeguard against a no-deal Brexit at the end of the year, or a negotiating tactic by the British government, Brexit talks are likely to intensify and become the focus over the next month. This could mean that the sterling will have greater downside potential against the euro, and consequently put downward pressure on the euro against the dollar, the legislation is a signal that the UK's best alternative to a trade deal with the bloc has become a hard Brexit coupled with this legislation.

EUR/USD may still underperform moving forward thanks to stalling Brexit negotiations

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As a result, EUR/USD may have some downside potential in the short-term as well as the medium-term. Today's ECB monetary policy meeting - and subsequently ECB President Christine Lagarde's speech following the decision, may push EUR/USD down closer towards 1.1706's level. This support level still appears to be relatively robust, which should suggest that we may see some recovery in the currency pair following the decision. Over the medium-term, we lean bearish on the outlook of the currency pair, and forecast a regression back towards the 50-day moving average and possibly undercutting it into a new downward trend.

Technical Analysis:

EUR/USD

While fundamentals suggest that EUR/USD has more downside potential than upside potential, the currency pair still shows relative strength. The currency pair has managed to make new highs over the past month but is looking to currently be trading in a transition range. As it comes closer to retesting one-month lows. While the EUR/USD recovered on Wednesday from its most recent low, we will be looking for a confirmation from MACD for a re-entry into bullish territory. Failing that, we see the currency pair retesting the low at 1.1706’s level and possibly breaking that level to form a new bearish trend.

Support: 1.1799 / 1.1706 / 1.1625

Resistance: 1.1899 / 1.1951 / 1.2023

EUR/USD Chart (H4)

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