ING: EUR/USD Exchange Rate Could Fall 1.5% on ECB Decision
The euro to dollar exchange rate is expected by analysts at a leading European bank to sink following the key March European Central Bank policy decision on Thursday.
- EUR/USD at 1.0987 on Wednesday as markets consolidate ahead of ECB decision
- Markets weary of betting against the single currency, but shorting EUR is now seen as "the better risk/reward play tactically" by analysts CitiFX.
- We see risk of fall in EUR/USD to 1.07
The ECB is widely expected to ease monetary policy this week yet the euro refuses to fall, which leads many investors to wonder if easing has been completely priced in.
No doubt markets remain wary of a repeat of the punishment received last December when they bet against the euro only to be received by an underwhelming set of announcements from President Draghi and his team.
Nevertheless, there is chatter suggesting that markets are now so cautious that risk-reward is skewed in favour of betting against the euro.
Flows are worth a thousand words and the CitiFX Flows team seeing the largest net selling of EMU core bonds in a year last week while the short-term focused hedge funds get cold feet, buying back some of their selling of EUR seen over the past two weeks.
"The ECB’s mantra is to surprise and with positioning now decidedly leaning towards a less dovish ECB," say CitiFX, "shorting EUR is now seen as the better risk/reward play tactically."
Also warning of a surprise is Kathy Lien at BK Asset Management:
“Since analysts are predicting an increase to the QE program of anywhere from zero to 20 billion euros, the wide range provides plenty of room for surprise. In addition Mario Draghi could talk about doing more in the coming year that could also affect how the euro trades.”
Pound Sterling Live See Declines to 1.07
The risk of the ECB surprising with more-stimulus-than-expected and effecting further down-side in the EUR/USD pair fits well with our bearish technical forecasts.
The pair is stuck in a range between 1.0500 and 1.1500 in the medium term.
It has just moved higher in the last few days, and has reached the level of the Monthly Pivot Point at 1.1021, where it is currently situated.
The monthly pivot is a line constructed from the previous month’s High, Close, Open and Low prices, which traders use to buy and sell at, and which it is likely to provide an obstacle to further gains.
The MACD indicator in the bottom pane is below the zero-line which is a bearish signal, and indicates the pair will probably start to move lower again soon.
Confirmation of further down-side would come from a break below the 1.0800 level, to an initial target at 1.0700, and then the S1 Monthly Pivot level at 1.0663.
ING Forecasting the Euro to Fall
ING meanwhile forecast the EUR to USD pair will fall by at least 1.5% at the meeting as they expect the ECB to introduce a wide tool-kit of quite aggressive monetary policy measures.
One such measure available to the ECB is to increase by 5bn the amount of assets the central bank purchases each month.
Currently the Eurozone's central bank spends 60bn per month buying assets from banks – mainly bonds or IOUs – in a scheme which is designed to provide those banks with liquidity.
The idea is that by doing this more money to lend to businesses and people in the wider economy is being made available.
This flood of cheap money pushes down the value of the euro in a classic supply and demand function whereby the more of something there is, the lower the value it commands.
ING analyst and author of the ING report Viraj Patel reckons the new easing measures due to be announced on Thursday will result in a 1.5% fall in the euro to dollar exchange rate.
Using today’s exchange rate as a guide, a 1.5% fall, would see the EUR/USD go from 1.0958 to 1.0790.
What to Expect: Deposit Rate Cut
The ING note also forecasts the ECB to cut its deposit rate by 0.2% - or 20 basis points - to -0.5% in an effort to discourage banks from saving and encourage them instead to spend the money to stimulate the wider economy.
Central Banks are often dubbed the ‘bank of banks’ because high-street and commercial lenders save and borrow with them in a similar way individuals and businesses save and borrow from high-street or commercial banks.
This means that banks depositing or ‘saving’ with the ECB will not earn any interest –in fact they will actually have to pay the ECB 0.5% a year for the privilege of depositing their money in its ‘vaults’.
If the cut in the deposit rate goes through, the euro will probably weaken as a result because it will lead to an increase in the supply of money in the system, which devalue its worth.
ING’s Patel argues investors are only expecting the ECB to cut its deposit rate by 0.1% (10 basis points) and, if they are right with their call for a 0.2% cut, then the Euro will probably weaken, from the surprise factor.
Taken together their forecast scenario appears to indicate a minimum 1.5% fall in the EUR/USD pair:
"The fact that still somewhat less than 10bp of rate cuts is not priced in by the market (ie, the market is pricing a little bit more than a 10bp cut vs our call of a 20bp cut) and EUR5bn increase in monthly QE should be worth of around 1.5% downside to EUR/USD on the day.”
Tiered System
ING also expects the ECB to introduced a ‘tiered’ deposit rate system, similar to that introduced by the Bank of Japan (BOJ).
The purpose of such a measure would be to help reduce costs for banks having to pay the ECB’s negative deposit interest rate.
Banks have complained that the current -0.3% deposit rate is strangling their profitability and having the opposite effect ie constraining their ability to lend; to that intended, ie increasing lending.
In such a system, the ECB might only apply the new lower rate to additional current account deposits and charge any existing deposit rates at a less negative rate or not at all.
ING are not the only bank to believe the ECB will opt for this strategy, J P Morgan also think the ECB will use a two-tiered system:
"Our view is that the ECB will engineer a two-tier system to reduce the cost of negative rates for the banking sector and at the same time will leave enough liquidity at the lower bound."