Perhaps the most important event for financial markets for the rest of December is the European Central Bank (ECB) meeting scheduled for next Thursday. It is of significant importance for the Euro area’s economic recovery in 2021 and of particular importance to Euro traders.
The moment has surely built for the ECB. It is often common for the market to pressure a central bank ahead of important decisions, and this December is no different. The Euro, the common currency of the Eurozone countries, has been on a tear higher. It gained against pretty much every developed country’s fiat currency, in particular against the U.S. dollar.
This is a major issue for the ECB, one that has no solution at the moment. The central bank did manage to buy some time in the summer with its verbal intervention by the time the EURUSD exchange rate reached 1.20. However, time passed, the ECB did not do anything specific about it, and the markets sent the exchange rate close to 1.22.
What Might the ECB Do Next Week?
The ECB pre-committed to act at the next week’s meeting, but it had already communicated all its moves. Part of the forward guidance commitment, it puts considerable effort in letting the market know what it plans to do.
The only problem with this approach is that the market starts discounting the effects of a decision, the more details the policymakers give, and the more time passes. For instance, the ECB made no secret that it is not happy with the EURUSD at 1.20 – the market reacted, sold the pair to 1.16, but then moved it back to over 1.21. Is the ECB’s message still clear? Yes, but the market does not take it seriously as long as the central bank does nothing. In other words, only verbal intervention without acting is just words.
Some things are already priced in – no rate cut, improved TLTROs conditions, and even increased Quantitative Easing (QE). All point to easing financial conditions further, but the higher exchange rate remains a drag.
Can the ECB overdeliver? Yes, and the only card it has in its hands is to push further against the higher EURUSD exchange rate. It has several ways it can achieve that, besides just introducing the exchange rate in the statement.
Failure to do so, means the exchange rate is not quite a problem for the ECB, but in doing so, it may send the wrong signal to market participants regarding its credibility. Prepare for a wild ECB meeting next Thursday.