Euro Exchange Rates and the ECB: "Moderately Dovish Outcome Suggests some Downside Risks" says TD Securities

Above: File image of ECB President Lagarde. Image © European Central Bank, reproduced under CC licensing

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Euro exchange rates could find some life on Thursday's policy meeting at the European Central Bank which will offer some key guidance as to where Eurozone monetary policy is heading over coming months.

With a host of major central banks looking to pull back the extraordinary support they have offered their economies during the crisis, how the European Central Bank (ECB) positions itself could understandably have significant implications for the Euro.

"All else equal, our base case for a moderately dovish outcome suggests some downside risks for EURUSD this month," says Ned Rumpeltin European Head of FX Strategy at TD Securities in an ECB preview briefing.

Ahead of the event the Euro-to-Dollar exchange rate (EUR/USD) has settled into a stable pattern and churns around the 1.2180 level:

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If anything, the increasingly tight market in itself offers the potential for some decent moves on the outcome of the ECB event.

Foreign exchange markets will want to know if ECB President Christine Lagarde and her team are considering if now is the time to reduce their extraordinary support to the economy, which includes ultra-low interest rates and generous quantitative easing.

If the ECB say the economic rebound will be strong enough for them to consider reducing support via their quantitative easing programme - known as PEPP - in the future, then the Euro could appreciate in valuation.

"We look for the ECB to maintain the language in the press release that PEPP purchases will continue "at a significantly higher pace than during the first months of the year," says Jacqui Douglas, Chief European Macro Strategist at TD Securities.

"However, we think that purchases will ultimately be reduced in Q3 due to seasonal/liquidity issues, rather than the macro outlook or financing conditions," she adds.

Such an outcome could create a more ambiguous flavour to Euro trade.

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The great theme for foreign exchange markets at present concerns the speed at which the world's major central banks are exiting their Covid crisis support programmes, with those looking to make an early exit seeing their currencies better supported.

The New Zealand Dollar, Canadian Dollar and the Pound are three currencies that have all benefited of late from such a shift in direction their respective central banks.

"With several other of its G10 peers in starting to take steps toward the exit — or at least look in that direction — any clear indication the ECB plans the same would be a significant development for the EUR," says Rumpeltin.

Global inflation rates are rising sharply and there are some economists who say central banks risk stoking this price pressure unless they start reigning in the amount of 'easy money' they are providing through quantitative easing and ultra-low interest rates.

By tightening policy (raising rates, ending quantitative easing) these central banks could help cool inflation.

"Like other central banks, the ECB will view the near-term pick-up in inflation as transitory, with no impact on its longer-term inflation forecasts," says Douglas.

A subdued tone by the ECB on the region's economic outlook and a sanguine view on inflation combined with a reiteration of the steadfast commitment to maintaining support could therefore see the Euro going lower.

As always, the ECB event promises to be one where traders hang onto every line of the guidance and every word uttered by ECB President Christine Lagarde.

This might prove to be incredibly frustrating for those watching the Euro exchange rate complex as it can be hard to ascertain what is moving the market.

"Much will depend, however, on the precise language Lagarde uses in her remarks and how she may nuance the subject," says Rumpeltin.

"In the absence of an unexpectedly hawkish pivot, we see minor downside risks to EURUSD as a result of the June policy outing, at least from today's vantage point," he adds.