- France announces strict 5-week lockdown
- Germany shuts down hospitality sector
- Economic impact to be significant
- Lagarde tipped to respond
- Euro could decline under such a scenario
ECB Vice President Luis de Guindos, ECB President Christine Lagarde, and Director General of Communications Christine Graeff. Photo by Dirk Claus/European Central Bank
- GBP/EUR spot rate at time of publication: 1.1076
- Bank transfer rate (indicative guide): 1.0788-1.0866
- FX specialist providers (indicative guide): 1.0950-1.0976
- More information on FX specialist rates here
Will the European Central Bank's Christine Lagarde "rip up the script today" and deliver the kind of surprise that has the potential to shake Euro exchange rates?
The question is pertinent given the ECB's October policy meeting comes mere hours after the Eurozone's two largest economies announced they would enter into a new nationwide lockdowns.
Germany's Chancellor Angela Merkel said the country will enter a four-week lockdown from November 02 and announced measures that include shutting bars, pubs and restaurants. Gyms, cinemas and theatres are also to shut while hotels are to close to tourists but they can stay open only for "essential reasons".
Indoor gatherings are banned for more than 10 people and between more than two households and shops are to stay open but with a maximum of one person per 10 square metres.
France's President Emmanuel Macron announced more severe restrictions overnight, saying the country would enter a five-week lockdown that would see non-essential businesses close and travel outside of the home restricted to exercises, work and the buying of essential foods. Anyone outside of their homes will have to carry a document justifying their excursion, which can be checked by police.
Macron went further than many political commentators and economists had expected and the economic impact will therefore be more significant, and the ECB is being tipped by some economists to react accordingly.
"Lagarde needs to rip up the script today, we think she will," says Claus Vistesen, Chief Eurozone Economist at Pantheon Macroeconomics. "The ECB will signal that more stimulus is coming today; we expect more QE in December."
The foreign exchange playbook says when a central bank surprises markets the currency it issues reacts.
Markets had been expecting a steady-as-she-goes ECB meeting this week with policy makers laying out the groundwork for potential adjustments to the Bank's policy easing programme in November or December.
The risk is that the ECB strikes a more dovish tone and moves earlier; a surprise outcome that would likely impact on Euro exchange rates.
The Euro has already come under pressure against the U.S. Dollar this week as expectations started to build that Germany and France would tighten restrictions and the risk is that the ECB accelerates recent moves. The Euro-to-Dollar exchange rate is currently quoted at 1.1750 having fallen by close to a percent already this week.
The Euro also also looks vulnerable against the Pound which is finding some buying interest owing to positive developments related to post-Brexit trade negotiations, the latest details of which can be found here. The Euro-to-Pound exchange rate is at 0.9033 and risks going below 0.90 in the event of a market-moving ECB event, the Pound-to-Euro rate is currently at 1.1070 and risks going to 1.11 and above.
"The new lockdowns won't be as severe as in H1, but we're getting closer to the point at which the difference is semantics. In other words, if the major EZ economies shut everything but retailing and schools for a month, we're back to lockdown economics," says Vistesen.
Pantheon Macroeconomics had previously assumed the Eurozone would suffer a flat quarter of economic activity as a worst-case scenario, "but a sharp contraction is now in the cards," says Vistesen. "The ECB will have to change its tune today."
Pantheon Macroeconomics expect the ECB to signal support is coming, but they won't quite be ready to pull the trigger today.
Under a "very dovish" scenario economists at ING Bank N.V. say the EUR/USD exchange rate would be at risk of falling below 1.15, which would take the EUR/GBP to 0.90 and potentially lower.
Under such a scenario the ECB would signal the inflation outlook for next year has worsened and they are "highly concerned", while announcing risks are clearly tilted to the downside.
"Macron announced a near-full five week lockdown in France starting tomorrow (schools remain open), going further than many expected. Germany also announced a one-month partial shutdown, starting Monday (closing bars, restaurants and leisure facilities). The combined hit to Europe’s two largest economies raises pressure on the ECB which meets today," says Elsa Lignos, Global Head of FX Strategy at RBC Capital Markets.
The partial closure of the Eurozone's two largest economies means the ECB will likely find the risks to the economy are now firmly pointed to the downside. RBC's economists however don't expect the ECB to introduce further measures today but they will instead give guidance as to what might be forthcoming in November or December.
"Whilst an extension of the PEPP programme seems to be a done deal in December, question marks linger over whether rates can be adjusted downwards, and if so which ones. Also, whether TLTRO conditions can be extended in time and whether the tiering multiplier can be lifted after open debates. We expect Lagarde to drop hints on which way the ECB governing council is leaning," says Lignos.
Should the ECB hold tight and signal they need more time to assess recent developments, the Euro could find itself supported.
"The ECB will likely acknowledge the worsening of the COVID-19 pandemic, but will probably delay any new policy action to the 10 December meeting, which should avoid increasing pressure on the euro for now," says Robert Mialich, foreign exchange strategist with UniCredit Bank.
While recent developments do not favour the outlook for the Eurozone's single currency, some analysts have remarked at how resilient it is proving to be which could mean the downside potential is limited.
"Despite the second wave in Europe, the material downgrades to the near-term EZ growth outlook and the market expecting more easing from the ECB at the end of the year, EUR/USD has been fairly resilient for the amount of EUR specific negative news," says Petr Krpata, Chief EMEA FX and IR Strategist at ING.
Markets remain of the view that a clean sweep by the Democrats in November's elections will prove supportive of stocks and risk appetite, which would in turn weigh on the Dollar.
This topic will become increasingly relevant to foreign exchange markets as the vote draws near, meaning the main focus for traders will potentially shift away from Europe and to the U.S.
"The balance of risks seem fairly balanced. By and large, dips in to the low 1.17's are likely to continue being picked up by market participants whom anticipate a large US fiscal stimulus package will fuel EUR-strength in to year-end, irrespective of the current weakness in European domestic demand," says Lars Sparresø Merklin, Senior Analyst, FX Strategy, at Danske Bank.
The one risk related to the U.S. election is that the result is inconclusive, leading to weeks of legal wrangling thereby creating the conditions for a Dollar rally.
This, combined with ECB easing expectations, would prompt notably weaker Euro exchange rates.