ECB decision cheat sheet – 4 scenarios

The outcome of the ECB meeting and the subsequent press conference by Mario Draghi are not fully anticipated, contrary to previous decisions.

So far, this uncertainty translates into very steady markets. This calm usually precedes a storm. But in which direction will currencies go? Here is a short and quick preview or cheat sheet if you wish.

The baseline expectation is that the ECB will not act.

Update:  ECB leaves all rates unchanged again – EUR/USD bounces back up

Update:  Live blog of the ECB press conference.

Why leave policy unchanged?

• Core inflation is still at 0.8%, above the 0.7% trough.
• April inflation: The ECB and other analysts are certain that y/y inflation will pick up in April.
• Keeping the powder dry: Extreme measures such as QE or negative interest rates will be kept for the worst times, and at the moment, the euro-zone is enjoying a recovery (somewhat fragile though).
• Verbal intervention: The ECB successfully talked down the exchange rate away from 1.40. A strong exchange rate pushes inflation down and makes exports less competitive.

Why act anyway?

• Headline inflation, the ECB’s central mandate, fell to 0.5%, the lowest since 2009. This puts a lot of pressure on Draghi.
• Others’ experience: Japan didn’t see signs of deflation until it was too late.
• Hints: Some ECB officials talked about more readiness for action.
• EUR/USD: The exchange rate is high: 1.40 seems to be the line in the sand, but will the ECB act to push EUR/USD further away from the danger zone?

4 scenarios

1. No action, hints of upcoming move in May or June: high probability. In this case, EUR/USD should rise initially only to fall later on, depending on the conditions for action.
2. No action, readiness to act, but nothing else: medium probability. In this case the EUR/USD will rise and rise.
3. Negative interest rate: low probability, EUR/USD crashes and Draghi can’t help it.
4. QE: Very low probability (see Will the ECB ever really do QE?  for explanations). EUR/USD falls, but Draghi can stabilize it, depending on the details.

Towards the decision, EUR/USD is trading in a narrow range between 1.3750 and 1.3770. The 20 pip range can turn into a 200 pip range.

More:

• Draghi under pressure to boost flagging Eurozone economy
• EUR USD forecast  – Everything EURUSD related.