Wednesday, December 9, 2020

Expect limited downward pressure on the euro with an expansion and extension to the ECB’s PEPP program tomorrow

  • Dollar
  • Euro
  • European Central Bank


Analysts’ Pick: Expect limited downward pressure on the euro with an expansion and extension to the ECB’s PEPP program tomorrow

  • Sentiment among policy makers is unlikely to have changed since the last monetary policy meeting as the European economy continues to feel the impacts of renewed lockdowns
  • PEPP and TLTRO has already explicitly been expressed by policymakers as the preferred tools to tweak in the coming meeting this week; we expect both programs to be extended to Dec 31st 2021, and an expansion to the PEPP of about 400 billion euros
  • Limited downward pressure on EUR/USD is expected as the weak dollar outlook is likely to outweigh the ECB’s actions on the currency pair in the longer-term

Markets are expecting the European Central Bank (ECB) to ease policy at its decision tomorrow after explicit signals from both the central bank's statement and ECB President Christine Lagarde's post-meeting conference earlier in November. We expect the same as well, with a focus on an extension to the bank's Pandemic Emergency Purchase Programme (PEPP) and Targeted Long-Term Refinancing Operations (TLTRO III) to at least the end of 2021, i.e. a six-month addition to the current deadline at the end of June next year. In the PEPP's case, this also implicitly means that an expansion is necessary for the program to last up till the end of next year, likely in the ballpark of 400 billion euros. An expansion of that size will allow the ECB to continue its purchases at its current pace of about 16.6 billion euros a week with some extra headroom at a total envelope of 1.75 trillion euros to err on the side of caution in the case that there is a period which needs increased inflow of liquidity into the market.

Expect an expansion to the ECB’s PEPP to at least last the full year through 2021


In addition, the central bank will likely revise its forecast for GDP growth downwards in Q4 2020 and Q1 2021 to reflect the impact of second wave of the virus in the bloc. This would mean that the ECB's previous forecast of growth in Q4 2020 and Q1 2021 is likely to be revised into a contraction in Q4 2020 and a slower growth in Q1 2021. This outlook would be consistent with the current state of the European economy as well as signalled by economic data. In the case of inflation, we should see more concern from the ECB on that front due to persistence in downward pressure on prices at already low levels.

A plunge in economic activity was mostly seen in services, although that will likely start to impact manufacturing after a month of lockdowns


Mobility-centric alternative data from Bloomberg shows activity in parts of the EU still in a rapid decline as major economies in the bloc extend lockdowns


Key risks to projections past 2H 2021 will lie in vaccines and its deployment in 2021. With the most recent wave of Covid-19 cases in the bloc starting to somewhat ease in major economies, the next logical step will be for the European governments will be focusing on vaccine distribution. The major progress in vaccines should be able to help keep the ECB's projections beyond 2H 2021 supported as a result, if the current efficacy levels published by vaccine makers hold through the year. That said, the central bank will likely prefer to err on the side of caution and play up possible risks that it sees in the near-term as opposed to being overly optimistic on the economic impact of vaccines.

Parts of the EU are starting to see daily Covid-19 cases slow, although risk is still present as it remains elevated relative to the prior wave


While this should put downward pressure on the already high EUR/USD pair, we expect it to be short-lived while traders return to trade the overall weakness in the dollar in the medium-term. This is especially so since the US appears to be moving towards a potential fiscal spending bill sooner-than-expected, with an even bigger spending proposal for 2021 being hinted by Democrats when President-elect Joe Biden takes over office. We expect a slight possible retracement downwards closer to 1.2083's level, before returning back higher above 1.2135's level to cement the currency pair's new support at the that level as a result. As for the longer-term outlook for EUR/USD, we expect the current uptrend to continue to be driven by investors positioning for a weak dollar, but at a slower pace than before thanks to downward pressure from the weak outlook to the European economy.

Technical Analysis:


Upward momentum in EUR/USD has been strong with only recently some signs of slowing. But with the market set on positive economic impacts from the successful developments of vaccines, we do not see key risks to the currency pair in the short-term materialising that would cause a return to the trading range seen in Q3 2020. Instead we expect momentum to slow as vaccine optimism continues to ease while weakness in the dollar takes a pause for the end of the year. Range-bound in our view is the more likely scenario in the near-term as a result, with the currency potentially settling in a trading range between 1.2135 and 1.2224.

Support: 1.1946 / 1.2003 / 1.2083

Resistance:  1.2224 / 1.2345 / 1.2545

EURUSD Chart (H4)