Currency and fixed income traders will have a busy day with the European Central Bank (ECB) monetary policy decision under the spotlight. Today’s meeting may be the year’s most important for ECB President Mario Draghi, who is due to step down in October.

The latest economic figures from the Eurozone were not encouraging as the closely-watched manufacturing purchasing managers’ index (PMI) hit a six-and-a-half-year low in July. Inflation remains well below the central bank’s target, and business sentiment is deteriorating. For Mr. Draghi, who pledged to do whatever it takes to save the Euro, action needs to be taken, and now the timing seems to be the most critical factor.   

The ECB meeting comes six days ahead of a similarly crucial policy decision by the United States Federal Reserve. While no one may admit it, we are likely living in a cold currency war.

If the ECB acts now by lowering deposit rates by 10 basis points and introduces a new stimulus program, the effect on the Euro may be short-lived if the Federal Reserve takes a more aggressive stance later. Mario Draghi and his team need the Euro to remain low in order to revive the deteriorating manufacturing sector and help exporters. Given that the ECB has fewer tools in their toolkit compared to the Federal Reserve, they may want to wait and see the Fed’s action first and act accordingly. That’s why the ECB may need to wait until September to introduce fresh economic stimulus but use the meeting later today to provide guidance. If the ECB doesn’t appear as overly dovish, this may lead to a sharp upward correction in the Euro to trade back within the range of 1.12 – 1.13.

However, we cannot rule out any surprises especially as there are more than 30% of market participants who believe that the ECB will reduce the deposit rate by 10 basis points today, taking it to -50 basis points. Out of the 67 economists surveyed by Reuters, five expect the ECB to lower the rate today, and Commerzbank is even anticipating a rate cut by 20 basis points. If the Commerzbank forecast plays out today, we may see the Euro easily dropping below its two-year low of 1.11.

Interest rates are not the only factor moving the Euro. Whether a new asset purchasing program is introduced is also of great importance, especially if it allows purchasing bonds yielding below -0.4%. This will put additional pressure on the Eurozone bond yields and hence the Euro.

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