The European Central Bank (ECB) is about to announce its decision on monetary policy. Only two days to go. The approval of more stimulus has already been appreciated, but the central bank may easily surprise financial markets. The big question is whether the ECB will offer more or less amount of stimulus.
At this time, the EUR / USD pair is trading above 1.21 and maintains a favorable buying tone. Of course, the exchange rate is the last thing on the ECB’s head, but it still matters. If for some reason the markets interpret tomorrow’s tone as hawkish, the euro could easily rise even higher. In that case, there is a risk that the stronger exchange rate will become a problem later.
How can the ECB surprise?
Thursday’s attention will be on the duration of the supportive political measures. The ECB has already communicated to the markets that it is not in favor of a cut in interest rates and, therefore, the focus will be on the two elements that are considered effective in this crisis: the PEPP and the TLTRO.
One thing the ECB is going to do is announce the expansion of its PEPP (Pandemic Emergency Purchase Program), basically a quantitative easing program. There is speculation in the market that the program will last until June 2022. In the event that the ECB chooses to do so, it must increase the amount by a few billion euros. The higher the increase, the bigger the surprise for the markets and the more dovish the message will be for the euro.
Another way in which the ECB could surprise the markets is to also increase the APP (Asset Purchase Program), the traditional quantitative easing program. In this sense, the market is inclined to think that the ECB will wait until the review of its strategy is completed to decide on the APP. If you decide to increase the APP in December, it will be considered a hawkish move.
Finally, the ECB runs the risk of falling prey to its own strategy. He did nothing in October, preferring to take a wait-and-see approach, not knowing what the second wave of the pandemic might bring. Unfortunately, this translated into momentum in financial markets ahead of Thursday’s decision. Therefore, markets can easily become disillusioned even if the ECB eases as promised.
By failing to act in October, the ECB provoked the wrong sentiment from market participants. If the EUR / USD exchange rate is indeed a problem, it should have acted sooner.
Or maybe not?