ECB Faces Brexit Challenge

The UK EU Referendum Aftermath Has Reduced the impact of ECB Stimulus

The European Central Bank (ECB) is expected to keep rates and quantitative easing (QE) measures unchanged with the focus for investors being the words of President Mario Draghi that will address the central bank’s response to Brexit risks which he has already said could take up to 0.5 percent points from the European economy in the next three years. The European Central Bank (ECB) will publish its benchmark rate statement on July 21, at 7:45 am EDT to be followed by President Mario Draghi’s press conference at 8:30 am.

Leading indicators in Europe will put Draghi on the spot after the Brexit vote has diminished the potential benefits of the two monetary policy easing shots from his Bazooka. The German ZEW economic sentiment survey brought grim news as both the German and the Eurozone outlook was pessimistic with a -6.8 and -14.7 respectively. The ZEW polls 275 German institutional investors and analysts on the 6 month economic outlook and their views following the British vote to leave the European Union. European consumer confidence remains weak at -7.9 after the U.K.’s vote to leave from an already low -7.2 for the 19 member countries.

The EUR/USD has lost almost 1 percent in the past 5 days. Strong U.S. economic data has boosted the dollar as the interest rate divergence gap is forecasted to expand with deeper negative rates in Europe and hints that the U.S. Federal Reserve may raise rates later this year. The ECB is running out of conventional monetary policy tools and the market will be looking to Mario Draghi to signal their next move to boost European growth in the post-Brexit world.

The EUR/USD lost 0.078 percent in the last 24 hours. The pair is trading at 1.1002 after consumer confidence in Europe remains weak. The Euro rallied last week touching highs of 1.1166 only to give gains back after the strong U.S. retail sales and inflation data released on Friday. The U.S. has posted slightly stronger economic indicators following the shock outcome to the British E.U. referendum. U.S. non farm payrolls (NFP) was too close to the vote results to be fully priced in, but it brought the strongest pillar of the U.S. recovery back after the miss in May.

The U.S. added 287,000 jobs, the highest number since October and a shot in the arm for jobs data. The USD had been higher following the shocking Brexit outcome on flight to safety flows but now the fundamentals are driving the USD higher against major pairs. The market is now estimating the U.S. Federal Reserve could raise rates as early as September with a 25 percent chance that goes up 54 percent in December. Fed members have been on the record as saying the economy could “run a little hot” with inflation before a decision to raise rates. Given the uncertainty in the market it is not an unwise decision as there are still large unknowns ahead of the U.S. election.

One of the first negative impact of the Brexit collateral damage was the Italian banking system. The risk aversion triggered by the British voters drained confidence from risker assets and hit bad loans portfolios. The Italian government is caught between strict no-bailout rules from the European Commission and the protection of Italian deposits. One is bound to give and the Prime Minister has said it could be put to a referendum in October.

Former Bank of Italy Governor and now ECB President Mario Draghi has the tough job of managing the expectations of market as he works towards achieving consensus between member states towards more stimulus. The British exit could begin an exodus if the ECB does not clearly offer that staying in the Union is the best alternative for remaining members.

Market events to watch this week:

Thursday, July 21
4:30am GBP Retail Sales m/m
7:45am EUR Minimum Bid Rate
8:30am EUR ECB Press Conference
8:30am USD Philly Fed Manufacturing Index
8:30am USD Unemployment Claims
Friday, July 22
8:30am CAD Core CPI m/m
8:30am CAD Core Retail Sales m/m

*All times EDT
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