Some clue how to trade ECB news 5-Jun-2014

The following are the key points in Goldman Sachs note on the ECB meeting today

1- The rate decision will be announced at 12:45 London time. Given that a deposit cut was telegraphed a month ago, the main question is whether this decision will be in line with market consensus (a 10-15bp cut) or greater (say 20bp). In the former, we expect EUR/$ to be essentially flat into the start of the press conference at 13:30, while the latter could see the cross fall around a big figure into the start of the press conference. 

2- The next stop is the opening statement, which ECB President Draghi will read out during the early minutes of the press conference. This will broadcast what credit easing measures will be taken and reveal the latest inflation forecast. On the former, the strongest signal for EUR/$ downside would come if the ECB gives a headline number for the liquidity impact of credit easing (something like “…the combined measures are ultimately expected to inject EUR200bn in liquidity), while the least favourable scenario is a kind of “rolling” LTRO, for example where banks can get liquidity for new lending every six months. The latter example would likely be a disappointment to the market, taking EUR/$ higher by a big figure or two, while the former could see EUR/$ weaken another big figure or two (especially if credit easing surprises the market, i.e., a 4-year LTRO with broad collateral and favourable haircuts or larger-than-expected ABS purchases). 

3. In FX strategy, the single most important node in tomorrow’s decision tree is the inflation forecast, specifically that for outlying years. If the 2016 forecast is marked down to 1.3% or 1.4%, this would be a de facto strengthening of the ECB’s easing bias, since it would openly acknowledge that further easing measures are needed to bring inflation back to target. We see this as the strongest possible signal for EUR/$ downside, since it subsumes many different kinds of future easing, including Fed-style QE. We think this could take EUR /$ down another big figure or more, as the market updates its reaction function for the ECB. If instead the inflation forecast is left unchanged in the context of a reluctant easing, this will set the stage for EUR/$ to move back up to 1.39. 6. There is obviously lots of ambiguity in all this.

4- A lot will hang on wording, demeanor and emphasis, where there are many shades of grey. However, our basic view remains that the ECB will surprise on the dovish side tomorrow, given the drop in core inflation and the signal sent at the last meeting. 

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ECB ready to cut rates and push banks

The European Central Bank is poised to impose negative interest rates on its overnight depositors, seeking to cajole banks into lending instead and to prevent the euro zone falling into Japan-like deflation.

At its meeting on Thursday, ECB policymakers may also launch a loan program for banks with strings attached to make sure the money actually gets out into the euro zone economy.

It will be the first of the “Big Four” central banks – ECB, Bank of England, Bank of Japan and U.S. Federal Reserve – to go the negative interest rate route, essentially charging banks to deposit with it.

Even though the risks are limited of the euro zone entering a spiral of falling prices, slowing growth and consumption, the ECB is increasingly concerned that persistently low inflation and weak bank lending could derail the recovery.

The economy grew just 0.2 percent in the first quarter, and euro zone annual inflation unexpectedly slowed to 0.5 percent in May, official data showed this week, piling additional pressure on the central bank to step in.

“Consensus for action is high so there is a … risk the ECB under-delivers relative to the market’s lofty expectations,” said Andrew Bosomworth, a senior portfolio manager at bond fund Pimco in Munich.

Since ECB President Mario Draghi last month signaled the Governing Council’s readiness to act in June, policymakers have come out in force to discuss the ECB’s toolbox, feeding expectations that a broader stimulus package is in the making.

This is likely to consist of a cut in interest rates, which would push the deposit rate for the first time into negative territory and the offer of longer-term loans linked to further lending. Large-scale asset purchases remain a distant prospect.

Cutting the deposit rate below zero would see the ECB charge banks for parking their excess money at the central bank – a step it hopes will prompt them to lend out the money instead.

Economists in a Reuters poll expected the ECB to cut its main refinancing rate to 0.10 percent from 0.25 percent and the deposit rate to -0.10 percent from zero, on top of launching a refinancing operation aimed at funding firms.

They expect bank lending to rise as a result of such measures, but foresee only a marginal impact on the euro.

The euro has fallen about 4 U.S.-cents against the dollar since the ECB’s May meeting, hitting $1.3586 last Thursday.

http://www.reuters.com/

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