The European Central Bank is due to announce its latest policy decision on Thursday at 11:45 GMT. No change in policy is being anticipated by the Bank but the meeting will still attract plenty of attention as details about the terms of the new round of cheap long-term loans are expected to be revealed. The Bank will also publish its latest macro-economic projections, which could provide clues as to what direction monetary policy is headed.
As ECB policymakers head for Lithuania for the Bank’s annual external meeting, speculation about the forthcoming Targeted Longer-Term Refinancing Operations (TLTROs) is dominating market talk. There are concerns that the third-round of this funding scheme for Eurozone banks won’t be as generous as the previous one that carried the same negative interest as the ECB deposit rate of -0.4%.
Should the ECB opt for tighter lending terms for TLTRO3, the program is likely to have less of an impact in boosting borrowing across the euro bloc, and hence, growth. It’s possible policymakers would be minded approving another generous lending scheme after the Eurozone economy grew by a solid 0.4% quarter-on-quarter in the first three months of the year.
The uptick in growth could also lead to a small upward revision to the Bank’s growth projection for 2019. Back in March, the ECB slashed its forecasts for 2019 and 2020 as the outlook dramatically turned gloomier. Although there’s still plenty of dark clouds hanging over the Eurozone, the resilience of domestic demand appears to be supporting growth for the time being.
But while there may be some positive surprises to the growth forecasts, the inflation projections may be more telling as there’s still no clear trend that underlying inflation is on the way up. The unexpected jump in both headline and underlying inflation in April was seen to be a temporary effect from the timing of Easter and the two measures fell back sharply in May in this week’s flash readings. A downward revision in the inflation forecasts would signal the ECB is not anticipating any pick-up during the forecast period.
Some traders could interpret this as a sign the Bank is open to returning on an easing path in the coming months. At the last meeting, Governing Council members were worried about the recent decline in inflation expectations. The five-year market-based expectations of inflation continue to slide, hitting the lowest since September 2016. Should President Mario Draghi reiterate the Bank’s concern about this trend in his press conference, the euro is likely to face some downside moves.
It would also pile pressure on the ECB’s newly appointed chief economist, Philip Lane, to devise fresh policy options to put forward to the Governing Council to combat the muted inflation picture. However, whether the ECB chooses to make a bold move, such as follow in the footsteps of the US Federal Reserve by adopting a symmetrical 2% inflation target, will probably depend on who will replace Mario Draghi when his term expires at the end of October.
In the meantime, Draghi will likely be quizzed about his home country by reporters as there’s renewed risks of a major clash between Italy and the European Commission over fiscal discipline. While Draghi will probably do his best to evade getting into a political debate, Italy’s rising debt level is bound to be worrying ECB policymakers, as well as simmering trade tensions and the ongoing Brexit drama.
All of the above are factors that have driven the euro to two-year lows against the US dollar and the single currency could again be testing that low of $1.1106 on Thursday if Draghi strikes a downbeat tone over the outlook.
Traders shouldn’t rule out some upside for the euro, however, as it’s possible the ECB won’t significantly lower its economic forecasts, if at all, and Draghi will sound cautiously optimism about the growth outlook. If that happens, and the dollar remains on the backfoot, the euro could extend its three-day bounce and challenge immediate resistance at $1.1280 before aiming for the April top of $1.1325.
