European Central Bank monetary policy announcement scheduled
today is one the most important event risks of the week. Analysts should not be surprised
if EUR/USD pair broke below 1.10 ahead of this rate decision.
Investors have big expectations for this meeting because of
widespread deterioration in the Eurozone economy and talk of recession in
Germany. EUR hit a 2-year low last week against the USD as German bund yields
tumbled deeper into negative territory.
Back in July, Mario Draghi, Chief of European Central Bank
brought up the benefits of a combination of measures and since then the need
for stimulus intensified. While investors are preparing for a massive dose of
stimulus, there's also a reasonable chance the ECB may under deliver.
The Eurozone economy needs help. Retail sales, inflation,
employment and manufacturing activity slowed across the region and in Germany,
growth contracted in the second quarter. The region's largest economy is
crippled by weak global growth and a collapse in manufacturing. Not only did
the PMI manufacturing index fall for the eighth month in a row but it reached
to its weakest level in 7 years.
The Bundesbank said there's a very good chance that Germany
will fall into a technical recession in the third quarter. With a tense trade
war and weakening US and global growth, the grim outlook for the region is why
the ECB needs to find ways to stimulate the economy.
The European Central Bank has many options including a rate
cut, stronger forward guidance, a new program of asset purchases and
compensation for banks to relieve the negative effects of negative interest
rates. They prefer a combination of measures because they feel that a package
is "more effective than a sequence of selective actions."
The market expects a minimum of a 10bp rate cut. If the
central bank combines this with rate tiering or a new Quantitative Easing
program, EUR/USD will sell off aggressively but if all they do is cut rates and
strengthen their low rate pledge, euro will soar in disappointment.
With EUR so weak, less aggressive measures could trigger a
sharp short squeeze in the currency. Unfortunately, there's resistance to a
package that includes QE - one of the strongest forms of easing.
Bank of France Governor Villeroy is skeptical of the
immediate need for QE while German and Dutch policy makers also believe its too
early for the move.
Given the market's lofty expectations, EUR/USD traders could
be setting themselves up for disappointment. Draghi could also opt for a
stimulus package that does not include the most aggressive measures to leave
his successor Christine Lagarde with ammo to fight a deeper slowdown.
