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Saturday, November 28, 2020

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The ECB should need to say something extraordinary to stop the Euro rally. Verbal intervention looks like the only option it’s not the time to change something in the policy. It is still too early to talk about expanding the limit of the main anti-crisis instrument (PEPP). The ECB also does not plan to touch deposit rate and change QE volume, and there is little sense in doing so. Given the structural downtrend in the dollar, the likelihood of a resumption of the bullish trend in EURUSD is high.

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To understand why we should not expect active actions from the ECB, it is important to keep in mind two points:

  • The ECB has gone too far in easing by making the rate negative and launching a fairly substantial QE, including PEPP with a ceiling of 1.35 trillion Euro. It is a well-known fact that with each new decrease in the interest rate, its marginal efficiency decreases. To achieve the same stimulating effect on lending activity, the rate should be cut more. However, side effects are also on the rise. With the interest rates below 0, it can be seen that the ECB prefers to use targeted measures such as TLTRO, etc., which is an evidence that easing potential has been largely exhausted.
  • The positive economic dynamics in the EU continued after the last meeting of the ECB, so the central bank does not have much reason to deteriorate its growth forecasts. Of course, there are concerns about inflation, which slowed down in August, but relative to the July forecasts, this is not such a strong deterioration. Markets are probably already considering that inflation forecast will be lowered by the ECB at its September meeting.

Christine Lagarde has only verbal interventions in her arsenal to stop the growth of the euro. But history shows that the European currency is recovering quickly after such comments. The ECB is approaching the September meeting having fully fulfilled the general credit easing program – negative rate on deposits, significant QE, PEPP program, which is expected to be expanded at one of the next meetings. The structural bearish trend in the dollar gained additional resilience after the Fed adopted FAIT, which has no immediate consequences, but is a commitment from the US Central Bank to contain borrowing costs much longer than other large central banks.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

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