ECB preview: QE back in focus

With the European Central Bank due to announce its latest monetary policy statement, are expectations for an extension to quantitative easing on the money? Would such an announcement even serve to devalue the euro?

December marks a time where the central banks are expected to kick back into gear after months of talk, with the European Central Bank (ECB) and Federal Reserve both highly likely to make changes to their monetary policy. The impending ECB meeting represents the first of the two events, with markets expecting to see Mario Draghi provide another boost with an extension to the current QE programme, due to end in March 2017. With this meeting looking to be one of the more interesting of recent months, it is worth understand what the ECB is likely to do and whether it will make a difference to markets.

Does Mr Draghi have a choice?

Put simply, not really. With less than four months left of the current QE programme, time is running out to set in place an extension of the current asset purchase scheme. The issue is that in order to end the QE programme, the ECB would need to implement a tapering plan to avoid an abrupt halt to the current easing package. Mr Draghi has already confirmed as much. With the current asset purchases standing at €80 billion per month, a US-style monthly €10 billion taper would mean the ECB could need at least a further eight months of QE to wean markets off the current stimulus. Alternately, an open-ended policy could see the committee implement an extension of around six months.

Mr Draghi is not one to talk up the euro or talk down markets and as such it makes sense the tapering plan is announced in the middle of a stimulus package, such as a QE extension.

From a data point of view, the economy is certainly showing signs of improvement, with the eurozone composite PMI reaching a 2016 high, while unemployment continues to fall (currently at the lowest level in 2009). Meanwhile, the inflation rate is finally in the ascendancy, yet remains some way from the 2% target. The ECB speculates that target will only be reached by 2019.

The market impact

Of course, according to economic theory, the extension of QE amounts to a rise in the supply of euros, thus driving weakness for the single currency. However, given the recent trend of markets moving in the opposite direction of expectations, it could be worth watching out for a potential euro rally.

Markets all expect some sort of extension from the ECB, which thus pushes the emphasis on to the finer details of the announcement. Given the break through the $1.0686 resistance level, we are possibly set for a period of strength, as EUR/USD retraces the $1.0525-$1.1300 decline in November. Should we see the extension accompanied by the implementation of a tapering plan, there is a good chance we could see the pair move higher.

Considering the recent trend of initial announcements seeing the intended response, followed by the counter trend move, an initial period of weakness could be a precursor to a swift reversal higher.

It seems somewhat of a foregone conclusion that we will see the ECB extend its QE programme, with more interest coming in the question over how the scheme is eventually stopped. Given recent market reactions, coupled with the fact much has already been priced in, we could see a move that runs counter to expectations. All in all, the meeting promises plenty of interest and volatility across European markets and the euro.

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