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ECB President Christine Lagarde
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European Central Bank policy makers are expected to take a wait-and-see approach when they gather virtually Thursday — but hopes for a continued recovery sparked by aggressive monetary policy actions and expectations for significant fiscal policy action from eurozone politicians could provide further upside momentum for the euro, analysts said.
The euro EURUSD, +0.07% has rallied 1.6% versus the U.S. dollar so far in July, changing hands Wednesday at $1.1401 after hitting a four-month high.
“The $1.14 level, which was briefly broken in March and again in June, seems to be standing in the way of the euro and a stronger performance,” said Steven Barrow, head of G-10 strategy at Standard Bank, in a note.
“This week’s EU heads of state summit and ECB meeting could both go some way to determine whether an upside break is possible,” he said.
The ECB will announce its policy decision at 7:45 a.m. Eastern on Thursday, with President Christine Lagarde set to hold a virtual news conference at 8:30 a.m. Eastern. EU leaders meet Friday and Saturday in Brussels.
Of the two, the leaders’ summit is the main event. It will see European Union heads of state and government attempt to reach agreement on a roughly 1.85 trillion euro ($2.1 trillion) package, which includes 750 billion euros in funds aimed at aiding the recovery of the region’s worst-hit economies.
The ECB, meanwhile, exceeded expectations at its last policy meeting on June 4, surprising investors by increasing the size of its pandemic emergency purchase program, known as PEPP, to 1.35 trillion ($1.54 trillion) from €750 billion, and extending its run from the end of this year at least through June 2021. The ECB pledged to continue reinvesting maturing principal payments at least through the end of 2022. Economists had penciled in a rise of around €500 billion.
The central bank “bought itself several months to sit back and watch how the economic recovery evolves before deciding whether or not to increase the envelope further,” wrote economists at Daiwa.
Meanwhile, yields on Italian government bonds have eased, narrowing the premium over German bund yields, while overall bond market volatility has diminished, they noted. And economic activity is picking up, suggesting the economy might not contract by the 8.7% penciled in as the ECB staff’s central forecast last month, the economists added.
Still, the door is open to taking further action down the road. And while easier monetary policy is usually a negative for a currency, diminished bond market volatility eases concerns about the survival of the euro, a positive factor. And improved growth prospects, a function of both the ECB’s efforts and the prospect for a substantial long-awaited fiscal boost, are seen as positives, too.
“The EU summit is also important in our view because the euro has been living on a promise in recent months,” Barrow wrote. “This ‘promise’ is that EU countries will agree to a plan for EUR750bn of coronavirus support which, not only aims to support those most in need, and not dependent on their subscription to the EU budget, but also sees joint euro debt issued to finance the plan.”
As for the ECB, there is the possibility of taking additional action, such as buying bonds that have fallen from investment grade to junk status — the so-called fallen angels, but policy makers are likely to hold off, he said.
“If the ECB stands still but EU leaders move forward on their EUR750bn stimulus plan the euro might just have the incentive to take $1.14 out of the equation for some time to come” Barrow wrote.
