ECB decides smaller asset purchases, but for longer | 09/12/16

• ECB decides smaller asset purchases, but for longer At its final gathering for 2016, the ECB turned interesting an otherwise quiet day as far as economic events are concerned. Yesterday, the European Central Bank kept all its three interest rates unchanged, but decided to slim down its monthly purchases to EUR 60bn from EUR 80bn previously, starting in April 2017. The purchases will continue until the end of December 2017, or beyond if necessary. Although this is a 9-month extension of the QE program, the reduction in the size of monthly purchases was initially interpreted by investors as QE tapering and as a result, they pushed the euro higher. EUR/USD emerged above the 1.0800 obstacle on that. However, as they continued digging into the statement, they found out that the Governing Council is willing the increase the program in terms of size and/or duration, if the outlook becomes less favorable or if financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation. The message became clear. This has nothing to do with QE tapering, it is just a “less for longer” decision. The subsequent reaction in EUR/USD was to plunge after hitting resistance at 1.0875 and to break back below the 1.0800 (R3) barrier. In the press conference following the decision, President Draghi repeated that the Bank can expand or extend asset purchases if needed and pulled another ace from his sleeve. He announce that the ECB intends to purchase securities with yields below the deposit facility rate. This is the point where EUR/USD fell below the 1.0700 (R2) hurdle. The rate continued its tumble throughout the rest of the day and fell below the support (now turned into resistance) level of 1.0630 (R1).

• With the ECB done for this year, all lights are now turned to the FOMC policy meeting next week. The Committee is widely expected to hike rates for the second time in a decade, something also evident by Fed funds futures, which are currently pricing in a 95% chance of such a move. Given that a hike is almost fully priced in, we expect the focus to be on the updated “dot plot”, the new economic forecasts, and Chair Yellen’s press conference after the meeting. Following the speculation of higher future inflation due to Trump’s promises of fiscal spending, the market will be looking on how fast the Fed is willing to hike in the years to come.

• With the monetary divergence dynamic in place, we expect EUR/USD to remain under selling interest, and perhaps challenge once again the psychological barrier of 1.0500 (S2) heading into that gathering.

• EUR/GBP felt the heat of yesterday’s decision as well. The pair initially spiked higher, but the advance remained limited below the key resistance obstacle of 0.8600 (R2). Then, the pair tumbled, fell below the support (now turned into resistance) line of 0.8500 (R1), and stopped near our support level of 0.8415 (S1). Although the rate looks able to correct a bit higher today, the price structure on the 4-hour chart still suggests a short-term downtrend. As such, I would expect a decisive dip below 0.8415 (S1) to open the way for the next support zone of 0.8300 (S2), defined by the low of the 5th of December.

• As for today’s events, during the early European day, Norway’s inflation slowed to +3.5% yoy from +3.7% yoy the previous month, matching the forecast. Despite the slowdown, this is still considerably above the Norges Bank’s target of 2.5%, and is still good news for policymakers, who hold their monetary policy meeting next week. The nation’s CPI data alongside the OPEC meeting outcome and the latest surge in oil prices may encourage the Bank to remain sidelined for the months to come.

• From the UK, the trade balance for October is coming out and expectations are for the nation’s deficit to have narrowed somewhat.

• In the US, the preliminary University of Michigan consumer sentiment index for December is expected to continue rising. The preliminary 1-year and 5-year UoM inflation expectations are coming out as well.

• We have only one speaker scheduled on Friday: ECB Executive Board Member Benoit Coeure.