ECB Preview: Balancing act

The ECB meeting should have a fairly muted affect on euro crosses as no policy action or significant changes in rhetoric are expected. But if there is to be any excitement it’ll come from Madame Lagarde’s press conference. The most difficult job for Lagarde will be to avoid coming across hawkish while communicating the ECB’s monitoring of upside inflation risks and ability to remain agile if the need arises. Historically, the bank prefers to make a move in conjunction with updated economic projections. In December, the ECB put their policy settings on autopilot with PEPP concluding in March, being supplanted by APP. The minutes from that meeting, indicated divisions within the governing council over inflationary fears and too much stimulus via asset purchases. Their voices will only have grown louder after this week’s German and eurozone inflation numbers, came in very punchy. Core eurozone inflation did beat expectations, but at least declined on the previous month’s number, while the headline figure was actually higher than last month’s figure. The fact that core declined will likely give the ECB some manoeuvrability at this week’s meeting.

The influential members like Lagarde and Lane continue to look through this as they believe it to be driven by temporary factors. Their focus remains on medium-term inflationary dynamics and this will be heavily dependent on the path of wage growth (currently 1.5% YoY). Additionally, the significant output gap should help to prevent inflation becoming more sticky at higher levels. Market based inflation expectations such as the 5y5y inflation swap remain well anchored below the 2% target. Spill over tightening from the Fed will be pushed back by Lagarde as she has done previously on the basis that Europe is at a different stage in their economic cycle compared to the US. Despite Lagarde making it very clear that rate increases in 2022 are unlikely to happen the market continues to tighten the screws with lift-off being pulled forward to July 2022 and 25bps priced by the end of the year. This challenging of the ECB’s credibility on rates guidance was an issue raised within the minutes, so she may want to address this head on.

EURUSD:

This cross has been rallying strongly off its recent low. Is this setting up for a short the rally style trade? Price is currently above the 50-day SMA and looks set to have its eye on the 1.135 range resistance from November last year. The RSI is also at the 52 region which has been a headwind for price previously. A good area to look at potential shorts on a dovish disappointment from the ECB would be around 1.135 or potentially lower if we see the RSI roll over and a reversal candle like a doji. 1.125 range support would be the initial target to monitor on the downside.

(Source: Tradingview - Past performance is not indicative of future performance.)

EURGBP:

EURGBP is an interesting one. Once again we’re close to the level which just can’t seem to break (0.83). It hasn’t been broken since Brexit. Will a dovish ECB and hawkish BoE be the catalyst to finally breach this key price level? Price has been struggling of late to clear the 21-day EMA as well as it aligning with the 0.835 resistance. The RSI is in no mans land around 44, so there is nothing to really extract from this indicator. Targets wise, on the upside 0.835 and 0.838 above there would be prudent to watch. On the downside, 0.83 is where attention should be placed.