ECB Meeting Preview - All about the Forward Guidance

Following the ECB’s recent strategy review whereby we saw a shift in the inflation target from below, but close to 2% to a symmetrical 2% with room for temporary overshoots when needed. They also made sure to emphasize it will be different to the Fed’s AIT. This has been done to try and remove the deflationary bias embedded in their previous inflation targeting regime. Housing has also been incorporated into their inflation calculations, which should help see some modest uplift in the Harmonised Index of Consumer Prices (ECB’s main inflation indicator).

I’m not expecting any major policy shifts at this Thursday’s meeting, however, an update to forward guidance as President Lagarde informed us will be given. Discussion surrounding other policy options such as the purchase pace of PEPP, increases in the size of the PEPP envelope as well as the programme’s maturity date will be pushed out to September at the earliest. Decisions around the transition from PEPP and the configuration of APP which will replace it will also be pushed further out. At most we may get some vague rhetoric about maintaining supportive conditions when moving to a post-pandemic world. I’d be surprised if we got more than that as decisions around QE usually coincide with updated economic projections for inflation and growth etc which will only arrive at the September meeting. Additionally, uncertainty has risen given the recent surges in covid across Europe. For these two reasons, in my opinion the ECB will want to take a wait and see approach. However, there will be pressure for the ECB to back up their new policy framework with solid forward guidance at a minimum to maintain credibility with further policy action following at upcoming meetings.

I think what we’ll see is an adjustment to the forward guidance by taking some of the language from the new strategy statement on monetary policy when rates are hovering around the lower bound. Obviously, the new numerical target of 2% will need to be added in, we could also see a change in wording from “sufficiently close” to “very close” when speaking about inflation meeting its target while rates remain pinned down. This would allow Lagarde to signal to the market a policy of “lower for longer” with a higher probability of reaching its inflation target, with even a temporary overshoot. To really enforce their credibility, the ECB could also tie their rate path to an explicit calendar date i.e. no rate hike until late 2024. That would be a dovish surprise for FX markets and put pressure on EUR crosses. For me, the balance of risks are tilted from neutral to dovish going into this meeting.

The EURUSD remains a prime vehicle for taking a short the rallies approach since it remains below its 200-day SMA. If price continues to weaken the 50-day SMA will likely make a death cross with the 200-day SMA continuing to keep the bearish outlook in place. The RSI is hovering slightly above oversold. For now the 21-day EMA is acting as dynamic resistance as price gets checked back lower on rallies. Price is in the center of its descending channel, indicating we could have further to fall. On the downside a key level to watch is 1.17 which is the March 31 low and horizontal support. On a rally back up 1.185 would be important coinciding with the 21-day EMA and horizontal resistance.