Markets
It’s D-day in Frankfurt. The ECB concludes its monetary policy meeting with eyes on President Lagarde’s press conference afterwards. A meeting which probably wouldn’t have gained much attention if it weren’t for Chief Economist Lane’s comments on the single currency. With EUR/USD testing the psychologic 1.20 mark for the first time since May 2018, he sent a warning shot last week by saying that the FX rate matters (when setting policy). The trade weighted euro gained around 5% since May which will be reflected in a downward revision of inflation forecasts (cheaper imports). Recall that June forecasts already expected CPI headline inflation to remain way below the 2% inflation target over the policy horizon (1.3% in 2022). Worries that euro strength will also lower growth projections (less competitive) seem overdone. ECB’s Schnabel pointed out that the positive effect from a weaker dollar on global trade at this stage outweigh the negative effects from euro strength. EMU Q2 GDP prints also faced upward revisions. News agency Bloomberg yesterday even ran a story that ECB forecasts would show more confidence in the economic outlook, which called off the test of intermediate EUR/USD support at 1.1754 and propelled the pair back above 1.18. Anyway, the Lane FX comments suggested that the ECB would step up its policy accommodation in case of a stronger euro. For many reasons, we think this is an unlikely scenario. Foremost, the ECB hasn’t much arrows left on its bow. The central bank withheld from turning the deposit rate even more negative throughout the COVID-19 crisis with negative side-effects (for the financial sector) outweighing the benefits. ECB’s Schnabel in a speech even pointed out that the pandemic flipped the balance further against using negative rates with lower loan-loss provisions no longer being an advantage. Adding to the QE-pile doesn’t make any sense either. The ECB is buying bonds at its fastest pace on record via APP and PEPP. On top, if any, recent comments by ECB governors (eg Müller yesterday) pointed more in the direction of reversing all emergency stimulus as soon as possible once the COVID-19 crisis ends. Liquidity provision is no longer an issue following the introduction of PELTRO’s. Stepping up the verbal intervention threat to an effective one only happened once in the ECB’s history. End 2000, the ECB intervened twice in the market to prop up an ailing single currency. Taking this into account and the fact that Lane until now is the only governor to talk about the euro, suggests that ECB’s Lagarde faces a difficult task at the press conference. She’s proven not to be the best communicator and risks stumbling down the road by not being able to keep the easing “threat” alive. In that case, we believe that the ruling EUR strength trend could get fresh vigor even if unpleasant for the ECB. EUR/USD 1.2011 (YTD high) is first resistance. A strong euro could help EUR/GBP’s advance to the sideways range top of 0.9176/0.9184. The recent leap higher was inspired by sterling weakness as PM Johnson threatens to overrule the withdrawal agreement without trade deal by the end of the year. We don’t expect the ECB’s policy meeting to have a big impact on FI markets. The German 10-yr yield spent Summer in a narrow trading band between -0.55% and -0.40% with no trigger for a breakout on neither side.
News Headlines
The Bank of Canada yesterday left its policy rate as expected unchanged at 0.25%. The BoC in its statement sounded rather optimistic on Q3 growth which might develop faster than expected. However, even as the economy moves from the recovery to recuperation phase of the COVID-19 pandemic, it will continue to require extraordinary policy support. The language on QE bond buying was a bit more neutral as the BoC said it will be calibrated to provide the monetary policy stimulus needed to support the recovery and achieve the inflation objective. The Canadian dollar gained slightly after the BoC policy announcement.
According to Bloomberg the European Union is studying the possibility of legal action against the UK over Prime Minister Boris Johnson’s plans to breach the agreement on Britain’s withdrawal from the bloc. According to a document seen by Bloomberg, the EU judges it may have a case even before the internal market bill is passed by the UK Parliament. The two sides will hold an emergency meeting today.
