ECB preview: where next for the euro?

The European Central Bank is back in the frame, yet with election risk looming, what can we expect from Mario Draghi and co?

European Central Bank building
Source: Bloomberg

Thursday sees the European Central Bank (ECB) return to the fold, with its latest monetary policy decision likely to be overshadowed by the rhetoric and sentiment around the future path of rates. The likeliness of a shift in actual policy is minimal, with markets instead focussing in on updated staff projections and the tone set by Mario Draghi in his statement and Q&A session.

Looking at the next move from the ECB, it is likely the current QE programme will need to be wound down at some point. Given the fact the EBC extended the current asset purchase programme until December 2017, there is also a chance we will see the scheme extended once more later this year. Until then, the only action that looks to be the focus of investors will be the potential for a tapering of the current programme. Mario Draghi certainly has a penchant for talking up the possibility of further easing, thus sparking a devaluation of the euro. The EUR/USD chart below highlights that there is typically a move lower for the euro around the announcement, yet this does not necessarily last.

There are a number of factors which will influence whether the ECB will start to push the markets towards a more hawkish thinking or not. Firstly, the price stability mandate of the ECB means the recent 2% rate of CPI should influence the committee towards withdrawing its stimulus, before it runs away. A high rate of inflation means consumers are seeing their real incomes deteriorate if wage growth falls short of the inflation figure. That being said, much of that 2% can be accounted for by a temporary rise in energy prices, which rose 9.2% over the month. With energy prices stripped out, the rate of inflation was 1.2% (see below). For that reason, there is reason to believe we could see a rather defiant Draghi, who could instead focus on the uncertainty associated with the raft of European elections due this year.

Euro area annual inflation and its components, %

  Weight (%) 2017 Feb 2016 Sep 2016 Oct 2016 Nov 2016 Dec 2016 Jan 2017 Feb 2017
All-items HICP 1000.0 -0.2 0.4 0.5 0.6 1.1 1.8 2.0e
All-items excluding:  
>energy 904.7 0.8 0.8 0.7 0.8 1.0 1.1 1.2e
>energy, unprocessed food 829.5 0.8 0.8 0.7 0.8 0.9 0.9 0.9e
>energy, food, alcohol & tobacco 708.8 0.8 0.8 0.8 0.8 0.9 0.9 0.9e
Food, alcohol & tobacco 195.9 0.6 0.7 0.4 0.7 1.2 1.8 2.5e
>processed food, alcohol & tobacco 120.8 0.6 0.5 0.5 0.7 0.7 0.7 0.9e
>unprocessed food 75.1 0.6 1.1 0.2 0.7 2.1 3.5 5.2e
Energy 95.3 -8.1 -3.0 -0.9 -1.1 2.6 8.1 9.2e
Non-energy industrial goods 263.1 0.7 0.3 0.3 0.3 0.3 0.5 0.2e
Services 445.7 0.9 1.1 1.1 1.1 1.3 1.2 1.3e

e=estimate

Looking at EUR/USD, there is reason to believe we could be in for a period of strength, given the potential for a double bottom. The failure to break below $1.0494 provided a clue that we are seeing an end to the downtrend experienced throughout February. A subsequent rally and closed candle above $1.0630 would provide a more bullish outlook for the coming period, with $1.0679 and $1.0730 representing particularly interesting areas of resistance to see the market turn lower once more.

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