Possible ECB Outcomes, Ensuing FX Reactions

Our economists are looking for Mario Draghi to turn softer, following the lack of an improvement in the data flow outside of Germany recently. We do not look for rate cuts this month however, although we believe the Governing Council might have discussed this as an option.

Over the past few days, the FX market has geared up for a more dovish tone from the ECB. While there is little doubt Draghi will be softer at the March meeting, the degree to which he endorses the possibility of refi and/or deposit rate cuts will determine the reaction in EUR/USD.

Indeed, as our rate strategists point out (see Strategy – EUR: Expected market outcomes from ECB meeting, 6 March), markets should prepare for four possible scenarios with different rate and thus EUR implications (see table on the following page).

1. No rate cuts this time but option of cut(s) was discussed. This is likely to be the most market-neutral outcome on rates and thus also for the single currency. With small declines in 1-2Y rates, this could weigh somewhat on the EUR.

2. No rate cuts and no discussion of this option. This would be the most supportive outcome for the EUR, as it should take rate cuts completely off the table. This is the only message from Draghi that could clearly reverse the latest euro slide in our view.

3. Refi rate cut by 25bp; no change in deposit rate. This would narrow the rate corridor and suggest that the ECB is wary of introducing negative deposit rates. This should induce a fall in 1-2Y rates and thus weigh on the common currency.

4. Both refi and deposit rates cut by 25bp. This would be the most negative outcome for the EUR as the ECB rate corridor would be kept unchanged and markets would be likely to start to factor in the chance of another cut later on. This is not a very likely outcome in our view, as we think the hurdles the ECB would need to overcome to let the deposit rate move into negative territory are significant.

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