Time for the ECB to step up, but how?

Mar 10, 2020
The main calendar event this week will be the ECB meeting, which will be the first test case of a major central bank since the coronavirus outbreak caused fear in the markets. With hardly any bullets left and confronted with an external shock which ‘normal’ economic policies are struggling to contain, this will test the new ECB President like never before.

After the Australian, US and Canadian central banks all slashed interest rates last week to alleviate the negative effects of the coronavirus impact on their economies, it’s now the turn of European policymakers to decide what course of action to take. Markets have priced in 5-10bps worth of easing to the current -0.5% deposit rate.

Lowering rates in this unprecedented mix of supply-side and demand-side shocks is a weak ‘antidote’ and even any positive effects on demand are now highly questionable, as fears intensify around consumers curtailing their spending and companies sending employees home, amongst many other measures and issues.

Whatever it takes?

Some commentators are harking back to previous ECB Governor Draghi who was known for trying to show the ECB’s willingness and ability to act. Sadly, the landscape is different now with a growing chorus of ECB members expressing their disdain at negative rates, as they believe policy is already extremely accommodative and there are adverse effects to the bank’s current unconventional measures. Indeed, this discord is probably a major reason why we did not see any coordinated move with the Fed and other major central banks last week.

Band-aid action really needs fiscal measures

The ECB has signalled a readiness for ‘targeted’ action, which really does reinforce the message that the European ‘lender of last resort’ has run out of ammunition. This may come in the form of liquidity injections to support businesses impacted by the virus, with a new TLTRO aimed at SME lending. We may also see some tweaks to the QE programme to mitigate the negatives on the banking system, and a potential reintroduction of the date-based forward guidance.

It seems fiscal measures like state guarantees, bridging loans and tax relief in some form are desperately needed to tackle the current shocks.

Remember too that we get an updated set of staff projections, but these were produced some two weeks ago, before the virus outbreak in Italy, so will paint a far rosier picture without the huge impact from Covid-19. Any economic hit from quarantining a quarter of the population in Italy for example, will not have been taken into account.

1.15 and beyond if the ECB disappoints?

EUR/USD is currently inversely related to market sentiment across equities and commodities, and continues to be driven by Fed expectations and the unwinding of short positions. If the ECB underwhelms, expect to see further upside to the January 2019 highs around 1.15. Next resistance beyond here is at 1.1570 and then 1.1640, while only a breach of strong support at 1.1239 would indicate the current advance has run its course.