Thursday’s European Central Bank monetary policy announcement is the most important event risk this week. The ECB is widely expected to ease monetary policy, making it one of the few central banks actively fighting COVID-19’s economic impact with fresh stimulus. Normally, the prospect of new easing should be negative for a currency, but investors bid EUR/USD sharply higher last month and there’s serious risk of a post-ECB euro rally.
When the central bank last met in late October, ECB President Christine Lagarde said the it is looking to recalibrate all instruments at its next policy meeting. She warned that a contraction can’t be ruled out for the fourth quarter and there’s “little doubt” that more stimulus is needed as the central bank “will be looking at (recalibrating) everything.”
With less than 24 hours to its announcement, we can expect the ECB to, at minimum, raise its Pandemic Emergency Purchase Program by 400 billion to 600 billion and extend it to the end of 2021 or, possibly, even 2022. More asset purchases are likely as well, but most economists are not looking for a rate cut.
Central banks consider a number of issues when deciding how to change monetary policy, but the most important are usually inflation, unemployment, growth and the exchange rate. Inflation is running at a year-over-year rate of -0.3%, which is very low. Price pressures are starting to move higher, with gas prices rising to their highest level since March. In October, the ECB said risks are tilted to the downside, but with the start of vaccine distribution, the outlook is brighter. There’s still a high degree of uncertainty (a word used by the Fed), but recent data hasn’t been terrible. In fact, there’s been more upside than downside surprises in Germany’s reports. The expectations component of the ZEW survey, factory orders and industrial production rose more than expected. A brighter economic outlook from the central bank could drive the currency sharply higher.
However, the strong currency is a big problem. Since its last policy meeting, EUR/USD appreciated as much as 3%. It rose from 1.17 to a high of 1.2175 before pulling back this week. The central bank admitted it was watching the EUR/USD rate back in October when it breached 1.19. Now, it should be even more concerned, as a stronger currency offsets easing. Will its concerns about the exchange rate be enough to offset optimistic comments? Probably not. But given how much EUR/USD has run up over the past month, the pair is also begging for a correction.
The Bank of Canada left monetary policy unchanged today and pledged to keep rates on hold for the next few years. This decision was no surprise after a surge in new virus cases and nationwide lockdowns. Like many other central banks, it sees vaccine developments as “providing reassurance,” but “until a vaccine is widely available,” it will be a “choppy trajectory.” USD/CAD found a near-term bottom after the rate decision. While the BoC did not reveal anything new, the fact that it remains cautious was enough to drive USD/CAD higher. Given how far the pair has fallen, further short covering could take USD/CAD as high as 1.29.
GBP/USD traded as high as 1.3478 before giving up all of its gains to end the day virtually unchanged against the greenback. Prime Minister Boris Johnson and EC President Ursula von der Leyen met in person today. We’re waiting to find out if any progress has been made on Brexit talks. Sterling’s price action suggests that optimism is fading, but anything can happen so be careful trading GBP. The Australian dollar shot higher, while the New Zealand dollar sank back. Although New Zealand manufacturing sales increased in Q3, the impact on NZD was nominal. However, the improvement in Australian consumer confidence helped to take AUD higher.