EUR/USD: Trading the European Central Bank Interest Rate Decision

Trading the News: European Central Bank Interest Rate Decision

What’s Expected
Time of release:        02/04/2010 12:45 GMT, 07:45 EST
Primary Pair Impact :    EURUSD
Expected:         1.00%   
Previous:         1.00%

Impact the European Central Bank Rate Decision has had on EURUSD over the last 2 meetings

January 2010 European Central Bank Rate Decision

The European Central Bank left its key benchmark interest rate unchanged at 1.00%  in January as expected as central bank president Trichet said that policy makers are doing all that they can to spur economic growth, while also signaling that officials will wait for more signs of economic recovery before withdrawing further emergency support. At the same time, the ECB president stated that certain principles must be respected on banker pay so institutions are able to lend,  and went onto add that “we’re not losing sight of our medium-term mandate: to deliver price stability.” Meanwhile, during the question and answer segment, Trichet publicized that “we [the central bank] will not change our collateral framework for the sake of any particular country.” Investors are pricing in zero percent probability that policy makers will raise rates at its policy meeting on February 4th according to the Credit Suisse overnight index swaps.

December 2009 European Central Bank Rate Decision

The European Central Bank left its benchmark interest rate unchanged at 1.00%  in December as expected, with the central bank President Jean-Claude Trichet stating that financial markets have improved and that a gradual withdrawal of emergency measures through 2010 is “appropriate.” Furthermore,  the ECB raised its economic outlook, with Trichet saying that risks for growth were “broadly balanced,” while adding that the central bank will hold its last tender of 12-month funds late this month. At the same time, the ECB stated that the improved conditions in the financial market have indicated that not all of the liquidity measures are needed to the same extend as in the past, and with regard to price developments, euro area annual HICP inflation has turned positive again after five months of negative rates.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

How To Trade This Event Risk

The European Central Bank is widely anticipated to hold the benchmark interest rate at 1.00% this month as the Governing Council aims to balance the risks for the economy, but the press conference with President Jean-Claude Trichet at 13:30 GMT could spark volatility in the exchange rate as investors weigh the outlook for future policy. A Bloomberg News survey shows all of the 55 economists polled forecast the central bank to hold borrowing costs at the record-low, while investors are pricing a zero percent change for a rate hike according to Credit Suisse overnight index swaps as policy makers hold a dovish outlook for inflation. Consumer price in the euro-region grew at an annualized pace of 0.9% in December, which remains well-below the 2% target for price growth, while the CPI estimate increased to 1.0% in January amid expectations for a rise to 1.2%, and the central bank is likely to sustain its current policy throughout the first-half of the year as they maintain their one and only mandate to ensure price stability. At the same time, the jobless rate increased to 10.0% in November from a revised 9.9% in the previous month to mark the highest reading since August 1998, while retail spending unexpectedly held flat in December, and the central bank may continue to provide support to the real economy in the months ahead as policy makers aim to encourage a sustainable recovery.

Governing Council member Axel Weber anticipates economic activity in Germany to grow at a “moderate pace” this year and said the “number of insolvencies should increase in 2010,” which will continue to add downward pressures on the labor market. In addition, the European Commission noted that the spillover effects of the financial crisis “have yet to materialize across the EU,” and stated that the jobless rate is “likely to rise further” as businesses keep a lid on production and employment. Moreover, board member Vitor Constancio said economic growth in Europe will remain subdued in the coming years, while President Trichet argued the governments operation under the single-currency will “have to be credible in having a path back to normal public finances” at the Global Economic Forum in Davos, Switzerland as the central bank starts to unwind its emergency measures. Nevertheless, ECB’s Yves Mersch said that the board is likely discuss next steps at the March 4 meeting, and reiterated that the central bank will continue the “progressive withdrawal from excessive liquidity” as the financial market and global economy improves.

As the ECB is expected to hold borrowing costs at the record-low this week, trading the event risk may not be as clear cut as market participants wait for the press conference with President Trichet, but price action following the rate decision could set the stage for a long euro trade as the central bank aims to normalize policy this year. Therefore, if we hear any hawkish comments from the central bank following the meeting, we will need to see a green, five-minute candle following the release to confirm a buy entry on two-lots of EUR/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance, and this risk will establish our first target. The second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to lock-in our profits.

In contrast, fears of a protracted recovery paired with subdued price growth could lead the Governing Council to hold a dovish outlook for future policy, and a shift in the central bank’s rhetoric could weigh on the euro as policy makers aim to balance the risks for the economy. As a result, if the ECB holds rates steady and expects price growth to remain below the 2% throughout the year, we will favor a bearish outlook for the single-currency, and will implement the same strategy for a short euro-dollar trade as the long position laid out above, just in reverse.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com