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Hawkish ECB Commentary May Push EUR/GBP back to Mid-January High

Hawkish ECB Commentary May Push EUR/GBP back to Mid-January High

Nick Cawley, Strategist

Talking Points

- Any hawkish outtake at Thursday’s ECB meeting will be seized upon by recently upbeat EURGBP traders.

- The central bank is expected to leave all policy measures unchanged but language will be key.

- See the DailyFX Economic Calendar and see what live coverage for key event risk impacting FX markets is scheduled for next week on the DailyFX Webinar Calendar.

Thursday’s European Central Bank meeting is widely expected to reveal no change to the current ultra-accommodative monetary policy stance but the accompanying statement is worth parsing to see if the central bank hawks are gaining more leverage. And while the EUR is under pressure from the USD, the single currency may still push ahead against a weak GBP, as Brexit worries still weigh on the UK currency.

The recent bout of strong European economic data will come as a relief to ECB President Mario Draghi and vindicate his monetary policy stance. With the latest GDP data showing Euro-Zone growth running at a respectable 0.4% q/q and 1.7% annually and with inflation touching 2% y/y in February, the central bank chief will be pleased with 2017 to date. And this policy is set to continue in 2017, with interest rates set to remain unchanged for the rest of the year while the ECB will continue to buy bonds until the end of 2017, albeit at a slower rate of EUR60 billion a month.

The problem that Mario Draghi may soon have to deal with is how to signal to the markets that the days of ultra-loose monetary are coming to a close. A sudden announcement would send markets into a tailspin, especially the fixed income space. German government bonds currently trade with negative yields all the way out to 8-years, while 30-year German debt offer a miserly 1.17%, especially when German inflation is running around 2.2% y/y.

One line in Thursday’s policy statement may be worth keeping a close eye on. Since March 2016, the ECB has always stated that the Governing Council (GC) “expects key interest rates to remain at present or lower levels for an extended period of time.” And it is the “lower levels” that market participants are increasingly focusing on. If these two words are dropped at tomorrow’s meeting, it will send a signal to the markets that the central bank now believes that any deflationary forces are behind them and that they acknowledge that growth and inflation are on track to meet ECB targets over the next one-to two years.

The latest ECB Staff Projections are also released Thursday with any upgrades to either growth expectations or inflation forecasts likely to underpin the single currency, especially against a weak GBP.

While the EUR may still be slipping against the USD, due to the latter’s heightened interest rate hike expectations, EURGBP still offers an opportunity to benefit from any hawkish ECB commentary. The pair have risen from a February 22 low of 0.84027 to a current level of 0.86765, yet a further upside is on the cards to the January 15 high of 0.88602 if the hawks on the GC get to flex their muscles. The UK currency is also under selling pressure ahead of the government triggering Article 50 by the end of March, when divorce proceedings start for real. Ahead of the ECB meeting, the UK Chancellor of the Exchequer will release his first Spring Budget which may well provide a set-up ahead of the ECB meeting 24-hours later.

Chart EURGBP Daily Timeframe (November 9, 2016 – March 8, 2017)

Hawkish ECB Commentary May Push EUR/GBP back to Mid-January High

Chart by IG

--- Written by Nick Cawley, Analyst

To contact Nick, email him at Nicholas.cawley@ig.com

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