ECB to Continue Loose Monetary Policy But Details in Question

Central Bank under pressure to issue convincing tweaks

The European Central Bank (ECB) is fighting to recover some credibility in the market communication failures in the past 12 months. The task at hand is how to juggle between introducing changes to the quantitative easing (QE) program that allow for more debt to be eligible for purchase and if possible extend the duration of the program. The market is confident that one of the two and in some scenarios both are possible, but the biggest question marks hang around the weak link of the ECB communication strategy: its rhetoric about the future. Central banks have moved away from forward guidance opting to return to less transparent methods of communication.

The EUR has depreciated versus the USD on the back of the end of the U.S. elections and higher inflation and interest rates expectations next year. The single currency has lost 0.7 percent in the last 12 months and inflation remains low, with the exception of energy increases that are a result of the Organization of the Petroleum Exporting Countries (OPEC) production cut agreement.

The ECB will release its monetary policy statement on Thursday, December 8 at 7:45 am EST and President Mario Draghi will host a press conference at 8:30 am EST to give further details on any updates to the central bank’s QE program. The central bank is expected to extending the QE program beyond its original March 2017 deadline even though on the surface things have improved, although there are upcoming challenges that question the stability of the Union as the Brexit process and electoral process across Europe could bring its existence into question.

The EUR/USD gained 0.435 percent in the last 24 hours. The single currency is trading at 1.0755 ahead of the monetary policy decisions from the European Central Bank (ECB). The USD has been losing momentum as the market’s focused moved to Europe and specifically its central bank awaiting the Italian referendum and the release of the ECB statement on Thursday.

German economic results continue to drive European optimism higher as both sides of the Brexit negotiations are still far apart on deciding a date for the break up. German Industrial Production posted a gain of 0.3%, well short of the forecast of 0.9%. The EUR has been sensitive to political risk as various elections and referendum are taking shape around the continent. The No win in the Italian referendum was already priced in as the ask was too big and with the defeat comes more instability for Italy. Next year will feature multiple elections in the major economies which could have a deep impact in the currency in the short term and could spell the end of the Union if anti-EU sentiment keeps rising.

Investors have already priced in an extension for the QE program, so if the ECB decides to wrong foot the market there could be a pullback as riskier assets did not face sell offs after the No win in Italy. The ECB has struggled with communication of its intentions and has not hinted that it will hold the original deadline in place. The actions of the ECB will be under the microscope as well as the words of its President when he faces questions from the financial press. Because the decision faced by the central bank is not clear cut it leaves a lot of room for speculation on the other options open and the market could punish the ECB for its lack of a firm tone in how to deal with a consistent low inflation if its decision not to extend could be read as a tapering signal for the end of Q1 next year.

Market events to watch this week:
Thursday, December 8
7:45am EUR Minimum Bid Rate
8:30am EUR ECB Press Conference
8:30am USD Unemployment Claims
Friday, December 9
10:00am USD Prelim UoM Consumer Sentiment

*All times EST
For a complete list of scheduled events in the forex market visit the MarketPulse Economic Calendar

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza