There is a growing chance that the ECB will not stay put (see our 4 scenarios) on its upcoming decision. Will the euro react negatively?
The team at Bank of America Merrill Lynch weigh in:
Here is their view, courtesy of eFXnews:
Avoiding more euro re-appreciation is the short run priority for the ECB, says Bank of America Merrill Lynch.
“In our view “talking dovish”, i.e. unambiguously recognizing the risks to their outlook and underlining the possibility to do more, should be the ECB’s first port of call for this week, while the resilience in the real economy data flow and uncertainty over the Fed stance makes it hard to get into action in September already, beyond possibly some minor tweaks to asset eligibility as a sign of goodwill. In the medium run though, we believe the negative risk to consumer prices from the Chinarelated turmoil matters more than the adverse shock on growth,” BofA argues.
“The ensuing revision in the ECB’s inflation trajectory – with Praet already acknowledging downside risks there – might force the Governing Council’s hand on beefing up QE by the year-end, in line of our long-held view that the inflation outlook would force the ECB into “more for longer”. In our view, announcing that QE will continue beyond September 2016 would be a powerful form of forward guidance, allowing it to maintain a suitable “policy gap” with the Fed,” BofA adds.
“Thus, the normal course of action for the ECB would be to respond by another layer of accommodation to maintain unchanged the “stance gap” with the Fed. However, the ECB will have to speak before the Fed, and even if the Fed decides not to hike on 17 September, the FOMC’s choice of communication around such a “non-decision” could have quite different implications (would it simply be “skipping” a meeting to wait for the dust to settle on the market, or would it reflect a more fundamental change of heart on the timing/necessity of normalization?). Given this uncertainty, “talking the currency down” by insisting on the possibility to do more rather than big, hard to reverse decisions, should be the natural slope,” BofA projects.
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