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

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

2011-10-05 19:22:00
David Song, Currency Strategist
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Trading the News: European Central Bank Interest Rate Decision

What’s Expected:

Time of release: 10/06/2011 11:45 GMT, 7:45 EDT

Primary Pair Impact: EURUSD

Expected: 1.50%

Previous: 1.50%

DailyFX Forecast: 1.50%

Why Is This Event Important:

According to survey by Bloomberg News, 41 of the 52 economists polled see the European Central Bank scaling back the benchmark interest rate from 1.50%, and lower borrowing costs are likely to spark a bearish reaction in the single-currency as the fundamental outlook for the euro-area deteriorates. At the same time, market participants are now pricing a 55% chance for a 25bp rate cut according to Credit Suisse overnight index swaps, and we may see the ECB also show an increased willingness to expand its nonstandard measures as the sovereign debt crisis drags on the economic recovery. However, we may see the Governing Council maintain a wait-and-see approach throughout the remainder of the year as the central bank preserves its one and only mandate to ensure price stability, and President Jean-Claude Trichet may talk down speculation for lower interest rates as European policy makers continue to see a moderate recovery in Europe.

Recent Economic Developments

The Upside

Release

Expected

Actual

Euro-Zone Producer Price Index (YoY) (AUG)

5.8%

5.9%

Euro-Zone Consumer Price Index Estimate (SEP)

2.5%

3.0%

Euro-Zone M3 Money Supply (YoY) (AUG)

2.0%

2.8%

The Downside

Release

Expected

Actual

Euro-Zone Retail Sales (MoM) (AUG)

-0.3%

-0.3%

Euro-Zone Unemployment Rate (AUG)

10.0%

10.0%

Euro-Zone Economic Confidence (SEP)

96.0

95.0

The expansion in the money supply paired with the renewed risk for inflation may lead the ECB to retain its current policy throughout the remainder of the year, and the rate decision could fuel the rebound in the EUR/USD as market participants scale back speculation for lower borrowing costs. However, the ongoing weakness within the real economy along with the drop in confidence may encourage the Governing Council to increase monetary support, and an ECB rate cut could spark a sharp selloff in the single-currency as interest rate expectations falter. Should the central bank scale back the rate hikes from earlier this year, the EUR/USD should give back the rebound from earlier this week (1.3145), and the pair may work its way towards the yearly low (1.2873) as investors raise bets for additional monetary stimulus.

Potential Price Targets For The Rate Decision

EURUSD_Trading_the_European_Central_Bank_Interest_Rate_Decision_body_ScreenShot040.png, EUR/USD: Trading the European Central Bank Interest Rate Decision

How To Trade This Event Risk

Trading the given event risk may not be as clear cut as some of our previous trades as we expect the ECB to maintain its current policy in October, but hawkish comments following the rate decision could set the stage for a long Euro trade as market participants scale back speculation for lower borrowing costs. Therefore, if the Governing Council endorses a wait-and-see approach for the remainder of the year, we will need a green, five-minute candle following the announcement to establish a buy entry on two-lots of EUR/USD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will generate our first target. The second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to preserve our profits.

In contrast, the slowing recovery in Europe paired with the heightening risk for contagion may lead the ECB to scale back the rate hikes from earlier this year, and the central bank may employ additional policy tools to address the ongoing turmoil within the financial system as the fundamental outlook for the euro-area turns increasingly bleak. As a result, should the Governing Council cut the interest rate by 25bp or talk up speculation for lower borrowing costs, we will carry out the same setup for a short euro-dollar trade as the long position mentioned above, just in reverse.

Impact that the European Central Bank Interest Rate Decision has had on EUR during the last meeting

Period

Data Released

Estimate

Actual

Pips Change

(1 Hour post event )

Pips Change

(End of Day post event)

SEP 2011

09/08/2011 11:45 GMT

1.50%

1.50%

-58

-167

September 2011 European Central Bank Interest Rate Decision

As expected, the European Central Bank kept the benchmark interest rate at 1.50% in September, but the dovish comments by President Jean-Claude Trichet raises the prospects of seeing a rate cut as the central bank curbs its outlook for future growth. As the slowing recovery in Europe dampens the risk for inflation, the ECB may take further steps to stimulate the ailing economy, and we may see the Governing Council show an increased willingness to expand its nonstandard measures in an effort to shore up the financial system. As the heightening risk for contagion continues to bear down on investor confidence, we are likely to see an increased reliance on the ECB to balance the risks for the region, and the central bank may revert back to its easing cycle as the fundamental outlook remains clouded with high uncertainty. The EUR/USD struggled to hold its ground following the announcement, and single-currency continued to lose ground throughout the North American trade, with the exchange rate settling at 1.3880 at the end of the day.

EURUSD_Trading_the_European_Central_Bank_Interest_Rate_Decision_body_ScreenShot039.png, EUR/USD: Trading the European Central Bank Interest Rate Decision

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

To be added to David's e-mail distribution list, send an e-mail with subject line "Distribution List" to dsong@dailyfx.com.

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View the Expo Presentation on ‘Trading the News’ For Additional Resources

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