trading news reports

EUR/USD: Trading the European Central Bank Rate Decision

Wednesday, 14 January 2009 11:12:39 GMT  |  David Song, Currency Analyst

The euro is likely to face increased selling pressures over the next 24 hours of trading as the European Central Bank is widely expected to lower the benchmark interest rate by another 50bp to 2.00%. A Bloomberg News survey shows that 46 of the 60 economists polled expect the ECB to deliver a 50bp rate cut as price pressures alleviate.

Trading the News: European Central Bank Rate Decision

What’s Expected

Time of release:                  01/15/2009 12:45 GMT, 07:45 EST

Primary Pair Impact :          EURUSD

Expected:                              2.00%

Previous:                               2.50%

Impact of the ECB rate decision on EURUSD over the last 3 months

December 2008 ECB Rate Decision

ECB President Trichet and Co. lowered borrowing costs by the most since the euro was established as the economy faces its first recession in a decade. Policy makers voted to slash the benchmark interest rate by 75bp to 2.50% amid expectations for a 50bp cut, and may continue to ease policy further as they expect economic activity to remain subdued ‘for a protracted period of time.’ Meanwhile, President Trichet’s went onto say that the central bank must ‘beware of being trapped at nominal levels that would be much too low,’ which suggests that the ECB is approaching the end of its easing cycle, but could be forced to increase their efforts over the coming months as policy makers expect price growth to average 1.4% in 2009. As price pressures continue to fall at a rapid pace, the ECB may continue to ease policy further over the coming months in order to maintain their 2% target for inflation.

 

November 2008 ECB Rate Decision

The European Central Bank lowered the benchmark interest rate by 50bp to 3.25% from 3.75% following the coordinated rate cut on October 8th. The ECB, along with the Fed, lowered the key rate by 50bp to 3.75% from 4.25% in order to avoid a global meltdown. Meanwhile, falling oil prices have certainly helped to taper the upside risks for inflation,  which would allow the central bank to hold a dovish outlook going forward. ECB President Trichet explicitly stated that policymakers may lower the benchmark interest rate further as they expected economic activity to remain subdued for ‘a rather protracted period’ of time, and may continue to ease policy throughout the next year as the economy heads into a recession. The remarkable shift in policy has clearly weighed on the euro, and may weaken further against the U.S. dollar as investors curb their appetite for risk.

 

October 2008 ECB Rate Decision

ECB policy members held the benchmark interest rate steady at 4.25% despite the downturn in the global financial market. The central bank was widely expected to hold a neutral policy stance as inflation remains well above their desired target, but could be forced to lower borrowing costs over the coming months as the spillover effects of the credit crunch spreads throughout the global economy. Increased turmoil in the financial sector has already led governments throughout Europe to step in as the lender of last resort, and policy makers may opt to take additional steps to avoid a severe downturn in the economy. Moreover, falling commodity prices should help to lower prices pressures in the near-term, which should allow the ECB to push inflationary concerns to the backburner as fears of a recession intensify.

How To Trade This Event Risk

 

The euro is likely to face increased selling pressures over the next 24 hours of trading as the European Central Bank is widely expected to lower the benchmark interest rate by another 50bp to 2.00%. A Bloomberg News survey shows that 46 of the 60 economists polled expect the ECB to deliver a 50bp rate cut as price pressures alleviate, while Credit Suisse overnight index swaps are showing that investors anticipate the central bank to lower borrowing costs by at least 75bp over the next 12 months. The significant drop in global commodity prices have certainly helped to taper the upside risks for inflation, and as oil prices slip below $40 a barrel, policy makers could be forced to step up their efforts in order to meet their one and only mandate to ensure price stability. Consumer prices in the Euro-Zone fell at its fastest pace since record keeping began in 1991 as the annual rate of inflation slipped to 2.1% from 3.2% in October. As a result, the European Union lowered the CPI estimate for December to 1.6% from 2.1% in the previous month, which is the first time in nearly two-years that price growth fell below the ECB’s 2% target. Moreover, producer prices dropped the most in 27 years as the index plunged 1.9% in November, which lowered the annual rate to 3.3% from 6.3%. As prices tumble lower at a record pace, policy makers will certainly have to address the risks for deflation in order to avoid a protracted period of price declines, but comments from the central bank suggests that deflation has yet to become a major concern. Bundesbank President Axel Weber stated that inflation expectations are well anchored to ride out the drastic fall in prices, and went onto say that the Euro-Zone is facing a period of disinflation rather than deflation. Meanwhile, ECB President Trichet reinforced Mr. Weber’s remarks as he said that ‘there is a limit to the decrease in rates’, and voiced his concerns of ‘being trapped at nominal levels that would be much too low.’ The comments from the policy makers suggests that the ECB is considering to take a break from their easing cycle, but as market participants price-in additional rate cuts by the central bank, the euro may weaken further against the U.S. dollar over the near-term.

 

The interest rate outlook for the Euro-Zone clearly favors a bearish forecast for the euro, and as a result, we would need a clear shift in policy followed by neutral commentary by ECB President Trichet to set the stage for a long euro-dollar trade. Once these conditions are met, we will look for a green, five-minute candle following the rate decision to validate a long entry on two lots of EURUSD. Our initial stop will be placed at the nearby swing low (or reasonable distance depending on volatility), and this risk will determine out first target. Our second target will be based purely on our discretion, and in order to preserve our profits, we will move the second lot to breakeven once the first trade reaches its target.

 

Nevertheless, as the risks for deflation intensify, the ECB may continue to ease policy further over the coming months as prices drop at a record pace, which is likely to weigh on the euro going forward. As a result, if the central bank decides to cut more than 50bp, we will certainly short the euro, and will follow the same set up as the long trade mentioned above, just in reverse.

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