Euro Exchange Rate: Will ECB Pull Trigger on Next Collapse in the EUR This Week?

Euro Rate Today: The new month has not started well for the shared currency which has lost ground against both the pound sterling and US dollar.

To be fair, driving the moves have been strength in both USD and GBP.

But, for the euro exchange rate complex nothing will be more critical than the meeting at the European Central Bank (ECB) where the next steps to fight the Eurozone slowdown will be debated and announced on Thursday.

While no major new measures will likely be announced markets will process each utterance made by President Draghi in order to try and calibrate their expectations on when the next bout of action will be announced.

Expect the shared currency to trade with a softer tone in the run-up to the event.  

For reference we see the following levels at the time of this articles most recent update:

• The euro to dollar exchange rate (EUR/USD) conversion is today 0.33 pct lower at 1.2342. 
• The euro to pound exchange rate conversion (EUR/GBP) is today 0.39 pct lower at 0.7887.
• The euro to Australian dollar conversion rate (EUR/AUD) is today 0.05 pct higher at 1.4673.

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The Problem for The Euro

2014 will be remembered as the year that the Eurozone recovery hit a brick wall despite the best efforts of the ECB to prevent such a scenario.

The November macro economic releases have not been brilliant in the Euro-zone. The headline CPI estimate retreated to 0.3% y/y as expected from an earlier 0.4%, the core CPI advance read steadied at 0.7%.

The unemployment rate remained unchanged at 11.50%.

Since the ECB started its covered bond purchases in October, 12.723 billion euro worth assets have been added to ECB balance sheet triggering a major period of weakness for the single market's currency.

"In addition, the ECB announced the start of the ABS purchases program two weeks ago, more details should be released in coming days regarding the operation. Despite the aggressive balance sheet expansion, the transmission in the real economy remains decidedly poor," notes Ipek Ozkardeskaya at Swissquote Research.

When Will the ECB Start Buying Government Bonds?

Be under no doubt - more action is coming, the only question remains when.

The big gun that will sink the euro significantly further will be sovereign quantitative easing - the buying of government-issued debt by the ECB.

Markets are not expecting the ECB to announce any new material policies on 4 December.

Despite ECB Predident Mario Draghi’s desire to turn up the money printing press, the broader Council seems to support a wait-and-see stance on the effectiveness of current policies, and weaker staff forecasts won’t surprise the Council.

We note a number of big-name economists, including the team at Deutsche Bank, expect public QE by the end Q1 2015.

It is for this reason that the outlook for the euro in 2015 remains negative.

The lead up to the announcement and the move itself, could well trigger the pound to climb and reach 1.3 GBP/EUR.

The euro to dollar rate could well fall to 1.2. The size and type of easing announced could see the euro fall even lower against sterling and the dollar.

ECB policy-makers have been building on the momentum towards full-blown sovereign quantitative easing at the last monthly meeting.

Draghi's speech last week conveyed a new sense of urgency.

Coeuré strongly hinted at a "discussion" on additional asset buying as early as next week, and Constancio drew the point home by explicitly discussing purchasing government bonds on 26 November.

"We don't expect hard decisions next week, but we now expect an announcement on "sovereign QE" by 5 March at the latest, with on balance a higher chance of a move by 22 January already," says Gilles Moec at Bank of America Merrill Lynch Global Research.  

BofA argue that further weakness in inflation relative to our outlook could push the ECB to act as soon as Q1.

The weak November inflation print and the additional decline in oil prices contribute to an expectation of inflation prints that will flirt dangerously with the psychological barrier of 0% in the coming months and will make a period of low inflation more persistent.

The Governing Council will need to address three distinct issues when considering QE say Deutsche Bank:

• First, the principle itself. We think that, while the impact of QE on the ECB's final target - bringing back inflation towards its definition of price stability - is likely to be disappointing, sovereign QE is now the best way for the ECB to deliver on its intermediate target, i.e. bringing its balance sheet back to its early 2012 level. The need to maintain the central bank's credibility should be enough, in our view, for a large majority of the Governing Council to ignore the entrenched opposition of the most vocal hawks, particularly with an even weaker inflation outlook.
• Second, the timing. QE in Europe will be first and foremost a signalling device, operating as a confidence booster. Thus the more the ECB waits the less impactful QE could be. In addition, the central bank may gradually erode its capacity to keep market rates ultra-low in the periphery, where political risks are rising. Buying peripheral securities would be a politically harder sell to the hawks once the market has started questioning debt sustainability. The window of opportunity is narrow. Still, the ECB won't be consistent if it embarks on QE before it is absolutely clear that the measures already approved are failing. The results of the second TLTRO on December 10 will be crucial from this point of view. This calls, in our view, for an announcement in Q1, rather than next week.  
• Third, the technicalities. We think QE would be less impactful if the ECB merely added sovereign bonds to the list of securities it can buy to achieve its balance sheet target without visibility on the pace of purchases. Disclosing a transparent pace would work better, but in our view the most efficient, and politically acceptable approach, would be an open ended commitment, with a quantified pace, offering the central bank some wiggle room to opt out in case of flagrant free-riding by governments. Purchases would continue until economic conditions are consistent with price stability, while taking on board risks for financial stability and for the quality of the ECB's balance sheet. We also think that bluntly applying the ECB capital key would create unwanted effects. Some refining will likely be needed.