Forex: Euro Gains Likely to be Limited on Status-Quo ECB Rate Decision

Talking Points:

• Euro Gains to be Limited on Status-Quo ECB Interest Rate Decision
• Bank of England Monetary Policy Announcement Likely a Non-Event
• Ukraine Crisis Still a Potential Trigger for Risk Aversion, Yen Gains

A monetary policy announcement from the European Central Bank (ECB) headlines the economic calendar in the hours ahead. Stubborn disinflation has fed speculation a possible move to ease monetary policy, and with good reason. A gauge of regional inflation expectations (derived from bond yields) is hovering near two-year lows while the benchmark year-on-year CPI measure of the price growth rate sits near the lowest levels since late 2009.

With that said, only fourteen out of 54 economists polled by Bloomberg call for the central bank to cut its benchmark lending rate. Meanwhile, investors are pricing in a mere 2 percent probability of a reduction. While we see the need to ease, we agree with the consensus view of an on-hold outcome this time around. We expect Mario Draghi and company will wait for the completion of the central bank’s Asset Quality Review (AQR) before easing further. Opting for the status quo this time around may temporarily boost the Euro,but with expectations heavily skewed in favor of that outcome already, follow-through is likely to be limited.

The Bank of England (BOE) is likewise due to deliver its interest rate decision. A non-event is likely on this front after February’s change in the forward-guidance regime telegraphed policymakers intention to keep things locked in place for some time. The benchmark 10-year UK bond yield conspicuously topped out and began to decline on the same day that guidance was augmented, pointing to deteriorating support from the policy outlook. The British Poundhas been capped below 1.69 to the US Dollar since then but significant downside momentum is yet to materialize. It remains to be seen whether a reminder of the BOE’s soft disposition will finally tip the sales. We have entered short GBP/USD.

The crisis in the Ukraine remains a significant consideration. From the markets’ perspective, the situation appears to be in wait-and-see mode at the moment but the possibility that unforeseen headline risk aggressively sparks renewed risk aversion is significant.Such an outcome is likely to renew traders’ desire for safe-haven assets, boosting the Japanese Yen.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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