EUR: Risks skewed to the upside ahead of ECB policy meeting - MUFG

Lee Hardman, Currency Analyst at MUFG, suggests that the proximity of the ECB’s upcoming policy meeting is triggering a lightening of short euro positions.

Key Quotes

“The risks for the euro from the meeting are skewed to the upside as it is difficult to see the ECB surprising the market by delivering a more dovish than expected policy signal. We expect the ECB to extend QE similar to consensus expectations by a further six months beyond March at the current monthly purchase pace of EUR80 billion. If the ECB delivers as we expect it is likely to prove neutral for the euro helping it to remain at current weak levels for longer.”

“However, there is a non-negligible risk that the ECB could begin to slow the pace of monthly purchases. One report has speculated that extending QE by nine months at a slower monthly purchase pace of EUR60 billion is under consideration. Slowing the pace of purchases would be seen as tightening monetary policy and providing more support for the euro. If the market judges that the tightening is premature and inflation expectations fall in the euro-zone, the ECB runs the risk of the euro strengthening more markedly. It is why we believe that the ECB should be cautious about withdrawing monetary easing at the current juncture especially following the rejection of constitutional reforms in Italy.”

“The ongoing improvement in the euro-zone labour market with the unemployment rate dropping to its lowest level since prior to the euro-zone debt crisis is providing encouragement for the ECB that underlying inflation pressures should gradually pick up in the coming years. The case for tapering for QE could be more compelling later next year if core inflation has already picked up by then.”