Are you ready for the ECB Meeting?
Posted on: 25 October 2017 , by: Darren Sinden , category: Market Review
Estimated Reading Time: 3 minutes
Here’s what to expect at the next ECB meeting, and potential scenarios for the Euro.
Markets believe that the ECB council will lay out a roadmap for balance sheet reduction, and the timetable for the end of QE (Quantitative Easing) at its October meeting. The central bank's balance sheet has grown from less than €2.0 trillion in late 2011 to a whopping €4.37 trillion as of October 2017.
The backdrop to the meeting
The ECB has been spending tens of billions of Euros per month over the last year buying assets to stimulate economic growth among single currency members.
Many in the markets feel that the time is now right for a reduction in this stimulus, and to allow the local economies and markets to stand on their own two feet once more. But as is the case with the USA, concerns remain about low levels of inflation and their sustainability.
The concerns at the ECB
The ECB would like to see inflation trending at or around 2%, but as of September, consumer price growth in the single currency area was running at just +1.5%; some 30% below target. There are signs that prices may be picking up and other economic data is pointing towards a continued EU recovery, that may give the ECB the confidence to act. But of course the Euro and its related economic data are derived from 19 separate states, and the central bank needs to consider what's right for all of them. Not just a chosen few.
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However, some practical factors that could influence the ECB's decision about whether or not to taper its asset purchases. That's because the central bank may have become a victim of its own success. As it regards its ongoing purchases of government and other assets, which are currently running at some €60 billion per month and have effectively hoovered up much of the available supply of those instruments.
What remains outstanding is largely to be found in the hands of long-term investors such as banks, insurers and pension funds. Many of whom are forced by regulation and the need to meet long-term liabilities, to hold onto the very instruments the ECB would like to buy. Some experts have suggested that the ECB would need to trim its purchases back to around €30 billion per month to be able to operate efficiently in 2018, given these supply constraints.
We can’t ignore politics either
The bank will also have half an eye on the political situation in Europe. Because as monetary stimulus is reduced, fiscal policy is meant to fill the shortfall. A move towards the political right in Germany, Austria and the Czech Republic in recent general elections, may make that goal harder to achieve. The politics of the situation are not the bank's concern per se. But it wouldn't wish to prematurely remove monetary support only to find there was no fiscal follow through.
What about the currency?
The Euro has appreciated by 12% year to date against its biggest rival the US Dollar. Those gains, particularly over the late spring and summer, were driven by disillusion with President Trump, his ongoing policy vacuum and therefore the Dollar as a whole. The question now is whether the Euro can sustain its current levels versus the greenback, and justify further gains into the end of 2017. Even as the Fed looks likely to raise interest rates at its own December meeting.
As such, the upcoming ECB gathering is probably the most pivotal of the year. If the market warms to the ECB decision (for example if the bank tapers its purchases but extends their duration) then the Euro should make further gains. Perhaps testing back to the early September high at $1.2092. However, if the ECB decides to take a more dramatic stance and chooses to cut its purchases to say €30 billion per month, without extending the timeline, it could be a very different scenario. That kind of abrupt action might spook the market and we could then see the Euro fall back through the mid-April uptrend line and retrace to $1.1480 and even $1.1290. I note that a strong euro is not really on the ECB agenda currently, so we certainly can’t rule out the latter course of action. The ECB announcement is scheduled for 11:45 am GMT (that’s 22:45 pm Melbourne time and 2:45 pm MT4 server time) with the press conference following 45 minutes later, at 12.30 pm GMT (23:30 Melbourne time, 3:30 pm MT4 server time).
What about the charts?
The chart above is dailly plot of Euro Dollar that highlights the move back below the mid May uptrend, which is rapidly ascending away from the current levels. I have also highlighted a series of consecutive shooting stars, in the red ellipses. These candles show the Euro rejecting higher levels, before trending lower. The Euro faces resistance at $1.1875 and $1.1937. With support situated circa $1.1689 and $1.1620. However I think it likely that sentiment will outweigh technicals on Thursday.
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*Calculated as the average and minimum spreads in ‘pips’ over a one week trading period between the 2nd and 6th of October 2017.
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