The European Central Bank (ECB) decision on Thursday is highly anticipated by financial markets. While recognizing the success of its lending facilities provided in response to the coronavirus crisis, the ECB is likely to further ease the monetary policy.
Some encouraging signs in the lending activity within the Euro area will likely cause the ECB to be slightly optimistic. March and April saw a broad-based surge in loans across countries, not only on short-term credit lines but also on long-term bank loans.
Staff projections, on the other hand, are likely to highlight the GDP contraction and to point to grim economic growth for the rest of the year.
Options for the ECB
The ECB is expected to increase the PEPP program by another EUR 500 trillion. It is already running at a steady pace, but with the new increase, the quantitative easing reaches a pace designed to further provide liquidity to corporations and businesses.
The ECB may surprise markets by announcing the reinvestment of the PEPP proceeds for a limited period of time, opening the gate for changes in capital keys. Moreover, some market participants expect that the ECB will start buying “fallen angels”, as it hinted previously, with direct implications for Italian companies and Italian rating in case of future downgrades.
It is also expected that the ECB’s Christine Lagarde will endorse the recent Next-Generation EU fund announced last week. A strong endorsement from the ECB for joint debt and grants across Europe may be a game-changer for the common currency for the rest of the year.
The ECB will likely also have to address the German constitutional court ruling that created so much confusion a month ago. As this is the first press conference after the Karlsruhe-based court deemed some of the ECB APP programs unconstitutional, Lagarde will face questions regarding the ECB’s response in light of that decision.
All in all, expect larger-than-usual Euro volatility. Heading into Thursday’s event, the Euro is higher across the board, with EURUSD starting the trading week above 1.11 and EURJPY struggling at 120.
As always, an exchange rate is about two currencies, not only one, but this week has the chance of being of crucial importance for the Euro. During economic crises, investors do not know what the overall market reaction would be to central banks’ decisions.
For instance, the ECB is expected to ease monetary conditions further. But if the market interprets it as a stimulus for the Euro area, the net effect on the common currency will be opposite to all expectations.