ECB Decision: Euro Exchange Rate Weakness Unlikely Today Argues ING’s Krpata

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It is Thursday the 21st of April - ECB decision day. What can we expect from the euro exchange rate complex on what is traditionally a volatile date on the event calendar.

No change in policy is expected at the ECB's next policy meeting due on Thursday April 21, given how soon it is after the 'bazooka' of stimulus measures already launched in March, and Draghi’s comments about further rate cuts not being warranted.

Instead the focus is likely to turn to President Draghi’s words at the post-meeting press conference

Hhowever, even if his tone becomes pessimistic, the downside effect on the euro is expected to be limited argues one prominent analyst we follow.

“With no action expected, the focus shifts towards President Draghi’s press conference. Our economists look for some dovish comments, yet its negative impact on EUR should be very limited as any strong pre-commitment to further easing should be absent,” says Petr Krpata, currency analyst at ING.

Having in many ways ‘used up its ammunition’ in March, the bank has nothing left which could materially affect the exchange rate.

“Our economists are looking for some dovish comments, whereby the ECB stresses downside risks to the economic outlook. Regarding the EZ inflation outlook, the failed OPEC meeting in Doha and what appears more limited upside to oil prices means it could take longer for the EZ headline CPI to reach the target,” says Krpata.

The EUR/USD is forecast to decline modestly if President Draghi takes a more dovish tone. 

But given that this is unlikely to be accompanied by a strong commitment to further easing at this point, "the euro is unlikely to depreciate much,” says Krpata.

Limited Impact on Economy from Lower Exchange Rates

Another reason why the euro may remain robust is that the ECB is less likely to target a weaker exchange rate as a policy tool.

In the past the ECB has joined other central banks in trying to prompt a weaker currency in the hope that it would stimulate foreign demand for Eurozone produce, and thus boost economic activity.

But there is a sense that the ECB's resources would be best spent on other fronts. 

Research presented by ECB vice-president Vitor Constancio suggests only a limited positive “pass-through” of a weaker euro exchange rate to the economy.

“With ECB Vice-President Constancio mentioning empirical evidence of 'limited pass-through of the exchange rate to the economy' in his recent speech on the effectiveness of monetary policy, the next easing measures from the ECB toolkit may not necessarily be solely focused on those that would have a large negative impact on EUR,” says Krpata.

If ECB Pessimistic Then Higher Yield Currencies To Gain

Krpata suggests high yield currencies may gain as a result of continued dovish rhetoric from ECB. 

The ECB should add to the theme that interest rates in the developed world are likely to remain 'lower for longer.'

With only a 50% chance of the Federal Reserve raising interest rates in 2016 being priced in by markets, we are is likely to see increased demand for carry trades.

Carry trading is the process by which investors borrow money in a low interest rate environment such as the Eurozone, where interest rates are only 0.0%, and buy a currency in a country with high interest rates such as New Zealand where they are 2.25%.

They can then pocket the difference in interest rate as a profit.

Increased carry trading, however, would be negative for the euro, which is a popular currency used by carry traders to buy the higher yielding carry currencies, due to it being cheap to borrow and highly liquid.