ECB expected to signal further easing likely - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the euro continues to grind lower against the US dollar ahead of tomorrow’s ECB policy meeting resulting in EUR/USD falling below the 1.1000-level.

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“Downward pressure on the euro increased yesterday following the release of the weaker than expected ZEW survey which has heightened concern over the outlook for the euro-zone economy following the Brexit vote shock. The ZEW survey revealed that confidence amongst investors in the euro-zone declined more sharply than expected. The more forward leading expectations component plunged by 34.9 point to -14.7 in July reaching its lowest level since August 2012. It was also the first time the expectations component has been below the current conditions component since the end of 2011 signalling strongly that the growth outlook is likely to weaken. The hope is that it could be an overreaction to the Brexit vote shock which could fade.

The ECB is expected to strike a more dovish tone tomorrow likely signalling that further monetary easing is under consideration in response to the negative shock from the Brexit vote. The release of the minutes from the ECB’s last policy meeting prior to the UK referendum clearly revealed that they believed that a Brexit vote could result in “significant, although difficult to anticipate, negative spill-overs to the euro area”. President Draghi has since reportedly told EU leaders that the Brexit vote could reduce economic growth in the euro-zone by a cumulative 0.3 to 0.5 percent compared to previous estimates over the next three years. A view broadly consistent with the IMF’s updated forecasts released yesterday in which they downgraded their euro-zone growth forecast for next year by 0.2 percentage point to 1.4%. It still remains above the current Bloomberg consensus forecast of 1.2%.

We expect the ECB to deliver further monetary easing in September when the staff’s economic forecasts are updated. It will be interesting to hear the comments from President Draghi tomorrow which may shed further light on whether the ECB is willing to lower rates further into negative territory, and potentially expand the universe of assets that are available to purchase under the QE programme. The health of European banks especially in Italy is also likely to be in focus.”