ECB President Mario Draghi gave a clearer indication at last weeks ECB meeting that the ECB may be more comfortable taking further “easing action” once it completes its staff forecast projections in early June.
We have seen an immediate market reaction with EURUSD falling from 1.3995 during the ECB press conference down to 1.3765 at the time of writing (a move lower of 1.63%). However what is not clear is what specific measures the ECB may or may not take to ease policy at next months 5th June meeting.
So what are the possible policy actions and how may the markets be impacted?
Firstly the ECB could embark on asset purchases (similar to QE in the UK & US) but I’m not sure the ECB has figured out how to do it yet in a European context (so watch ECB speeches in the next few weeks to assess QE readiness). Quantitative Easing (QE) would help accelerate the process of bank balance sheet adjustment, and detoxify some areas of bank balance sheets that could help kick start lending and investing. For the Euro currency impact it would be less clear, although reviewing the experience of both the UK and US we initially saw domestic currency weakness on the announcement of QE. So this could see EURUSD lower, but would this weakness be sustained?
Secondly the ECB could cut the deposit rate (the rates banks receive for depositing funds with the ECB), but will it prove effective in stimulating lending/borrowing and investing/spending? The concern must be for the ECB that, much like Japan in the 1990s and 2000s, such moves suppress consumption and investment in a deflationary environment, worsening the prospects for a rebound in inflation rather than helping. The impact on the Euro would likely in the near term be negative on interest rate differentials, therefore a lower EURUSD, but how low?
Finally and most likely (good news for all you tracker mortgage holders) is a cut of the benchmark interest rate from 0.25% to possibly 0.10%. However, if this is the only policy action then the markets may come away disappointed!
With respect to Euro, I’ve often seen that when the Euro makes a spike higher or lower and subsequently fails, it tries to retest the old highs before correcting again. This would suggest to me that the old highs of the year at 1.3950/60 should be very strong resistance as we head in the next meeting. 1.40 is certainly a key psychological level (1.3995 the high on 08-May-14 ECB meeting) but it is not a significant technical level other than that.
As we head through the month of May we probably face into a trading range of 1.3660 to 1.3960 until we get close to the 5th June meeting. It will then come down to the fact that the ECB really does have to act this time (after all the talk) and I believe they will to the detriment of the Euro in the near term. My key takeaway is that 1.40 is off the table for now and we may even see a 1.36 handle or lower for the first time in 2 months!