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How Can the ECB Disappoint the Markets?

David Becker
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www.iforex.com

The ECB has hyped up market expectations for further easing measures ahead of the June meeting and is under pressure to deliver. Another rate cut is likely although as this would bring the deposit rate into negative territory, most expect only a small move of 10 basis accompanied by alternative measures, which could include a conditional LTRO to boost lending to SMEs and an end to SMP sterilization.

Inflation expectations have changed considerably and a significant revision to the central bank’s medium term inflation outlook is not expected. So at this point a broad based asset purchase program seems unlikely, which squares with comments from ECB officials that QE is still some way off.

There is room for disappointment and the possible adverse effects of a negative interest rate aside, peripheral yields could push higher again if there is no announcement of ECB bond purchases. Market participants want to see a quantitative easing program installed to boost inflation and reduce the level of the Euro. Equity markets would surge on the back of this type of news, and growth would likely follow.

Draghi has shown that he is a master wordsmith, and that his bark is bigger than his bite. In this scenario, that is room for disappointment and the markets are poised to hammer stocks and rally the Euro if the central bank does not come through on its promise.

The euro has traded steadily into the ECB, with EURUSD holding a narrow range above 1.3600 after lifting from the Asia session low of 1.3594. Global macro hedge funds have raised their net short positions in the euro against the dollar from about 14% of net assets to about 18% over the past month. A short squeeze could easily be the in cards.

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