Forecasts for the euro – The ECB may not meet expectations

The monetary policy announcement of the European Central Bank of tomorrow is the most important risk event of the week and we are not surprised that the EUR / USD has fallen below 1.10 pending this decision on exchange rates. Investors have high expectations for this meeting due to the general deterioration of the eurozone economy and the possible recession in Germany. The euro registered a minimum of two years last week against the dollar, as the yield on German bonds fell further into negative territory. In July, Draghi raised the benefits of a combination of measures and since then the need to implement stimuli has intensified. Although investors are preparing for a good dose of stimulus, there is also a good chance that the ECB will not meet expectations.

The eurozone economy needs help. According to the following chart comparing the changes since the last ECB meeting, almost all areas of the euro area economy have weakened in the last two months. Retail sales, inflation, employment and manufacturing activity slowed down throughout the region and in Germany, growth declined in the second quarter. The largest economy in the region is paralyzed by weak global growth and the collapse of the manufacturing sector. The manufacturing PMI index not only fell for the eighth consecutive month, but also reached its lowest level in the last seven years. The Bundesbank said there is a good chance Germany will fall into a technical recession in the third quarter. With the tense trade war and the weakening of the growth of the United States on a global scale, the poor forecasts for the region are the reason why the ECB needs to find ways to stimulate the economy.

The European Central Bank has many options, including a rate cut, more aggressive forecasts, a new asset purchase program and compensation for banks to manage the negative effects of negative interest rates. They prefer a combination of measures because they believe that a package is "more effective than a sequence of selective actions." The market expects a cut of at least 10 basis points. If the central bank combines this with the stratification of the rates or a new quantitative easing program, the EUR / USD will be sold aggressively, but if what it does is to cut the rates and strengthen its commitment to keep them low, the euro will rise due to disappointment

With the euro so weakened, less aggressive measures could trigger a sharp brief uptick in the currency. Unfortunately, resistance to a package that includes quantitative expansion has been observed, one of the most effective forms of monetary relaxation. The governor of the Bank of France, Villeroy, is skeptical about the immediate need for quantitative expansion, while those responsible for the monetary policy of Germany and the Netherlands also believe that it is too early for this measure. Given the high market expectations, traders in the EUR / USD pair could be preparing for disappointment. Draghi could also opt for a stimulus package that does not include the most aggressive measures in order to leave ammunition to his successor, Christine Lagarde, to fight against a deeper slowdown.

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