-EUR retreats in volatile trading ahead of ECB’s March decision.
-Amid more risk-aversion, as markets eye Gov virus responses.
-ECB to cut deposit rate to new low, throw cheap cash at banks.
-Increase of QE program also possible as part of virus response.
-Some say ECB unlikely to dent EUR much given already-low rates.
-And see EUR continuing to benefit from risk aversion in markets.
-But the virus cost is mounting and it could be largest in Europe.
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The Euro-to-Dollar rate was in retreat ahead of the March policy announcement of the European Central Bank (ECB) Thursday, with many expecting a sizeable response to the growing coronavirus crisis that's hampering day-to-day life on the continent and threatening an already-weak economy.
Europe’s single currency was volatile ahead of the ECB’s decision Thursday, rising and falling by around half a percent against the Dollar around the European open as investors responded to overnight newsflow while taking up positions ahead of the 12:45 policy announcement of the ECB.
Price action comes after the U.S. announced sweeping travel restrictions on individuals coming from the EU’s Schengen area that will take effect from Friday, with Saudi Arabia following with similar steps while others are reported to be considering such moves. Countries are closing their borders to Europeans, with some citing the Schengen area as contributing to making the continent the largest detected coronavirus hotspot outside of China.
Above: Euro-to-Dollar rate shown at 15-minute intervals.
Those responses will further disrupt everyday life for European businesses when they’re already facing unprecedented interruption from efforts to contain the virus. Italy required the “closure of all commercial and retail activities, with the exception of grocery stores, basic necessities, pharmacies and parapharmacies” late on Wednesday. This is after Denmark ordered the closure of all schools and universities while instructing its public sector staff to work from home. And on Thursday Spain was reported to be mulling a 'lockdown' of its capital Madrid, Europe's third largest city.
"We as authorities, citizens and as a country right now have one task that is more important than any other: We must prevent too many people from being infected at once. As has happened in Italy," said Prime Minister Mette Frederiksen, in a press conference. "I would like to emphasize that we have a very strong commitment to help especially the weakest in our community, the most vulnerable, people with chronic illnesses, cancer patients, the elderly. For the sake of them, the infection must not spread."
Many of these measures are aimed at preventing an overload of healthcare systems as coronavirus cases and hospitalisations increase markedly in some countries, although they risk causing sudden stoppages in already-weak economies. And the ECB is expected to attempt to provide some form of support to businesses and households on Thursday as they grapple with the challenges.
“We expect the ECB to announce a substantial package today. The package will likely include a cut in the deposit rate, a more generous tiering system for bank deposits at the ECB, additional asset purchases focused on corporate bonds and liquidity injections designed to incentivise banks to provide more loans especially to small and medium-sized enterprises,” says Holger Schmieding, chief economist at Berenberg.
Above: Euro-to-Dollar rate shown at daily intervals.
Consensus still appears to be looking for the bank to leave its deposit rate at -0.50% and its main refinancing rate at 0%, although analysts are increasingly suggesting individually that a sweeping policy response is likely. Berenberg’s Schmieding says the ECB will chop the deposit rate further below zero, provide more cheap funding to banks through a targeted-long-term-refinancing-operation and increase the size of its corporate bond purchases.
“The most likely action that will reach most agreement will be on expanding the TLTRO program,” says Lee Hardman, a currency analyst at MUFG. “The second and much more contentious option would be for an additional rate cut to the deposit rate from -0.50%. We were initially sceptical of the ECB making this move but now suspect given the worsening situation in the euro-zone in recent days, that the ECB will reluctantly agree a 10bp cut to -0.60%."
ECB policymakers are constrained by the already-low level of interest rates and the significant stimulus that’s previously been provided through quantitative easing. Those measures have left the bank with little scope to reduce rates further while making it the owner of a large portion of the sovereign bond market, which is partly why Schmieding expects the ECB to buy more corporate bonds from Thursday onwards.
"The last time the ECB announced a similarly comprehensive package of easing measures was at the 12th September policy meeting. On that occasion, the EUR/USD rate opened on the day at 1.1010 and then initially fell to an intra-day low of 1.0927 before closing higher on the day at 1.1065. It highlighted the difficulty the ECB faces in pushing the value of the euro much lower. The ECB is likely to face the same problem again today," Hardman says.
Above: Euro-to-Dollar rate shown at weekly intervals.
Neglecting to act on Thursday would likely be unthinkable for the ECB after the Bank of England, Bank of Canada and Federal Reserve announced large 50 basis point interest rate cuts over the last week that either have been or are expected to be followed by government fiscal stimulus.
This is especially the case with coronavirus spreading at its fastest detected pace in Europe, although few if any see the ECB’s actions as being likely to engender any meaningful weakness in the Euro.
"We think the ECB measures will struggle to get EUR market rates much lower and EUR/USD can stay supported – awaiting action from the Fed. 1.1200/1220 looks important near-term support and favour a retest of 1.15 into next week as equities stay offered and the dollar sells off ahead of the Fed meeting. Elsewhere we’re surprised GBP is not doing better on yesterday’s powerful fiscal easing in the UK," says Chris Turner, head of FX strategy at ING.
Europe’s single currency rose 6.5% in the fortnight or so heading into this Monday and is still up 4.45% after being lifted by the closure of earlier ‘carry trades’ involving the Dollar and a range of emerging market currencies.
Unhedged investments in the U.S. stock market, made during better times, were also a factor too. Many of those positions have been liquidated already, boosting the Euro, although the remainder are arguably at risk of liquidation.
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