Tthree components of the ECB meeting to be considered - BBH

"There are three components of the ECB meeting that have to be considered," explains Marc Chandler, Global Head of Currency Strategy at BBH.

Key quotes:

"First, are the staff forecasts.  These are not simply an academic function. It is tied to policy in a way that the Fed's dot plots, for example, do not.  The market will be more sensitive to a cut in the inflation forecast than an increase in the growth forecast.  Projecting lower inflation would be understood as a dovish signal, and point to modest policy adjustment.     
Since the forecasts were made in June, the euro's rise has largely offset the rise in oil price, and while 10-year German bund yields are higher, French, Italian and Spanish benchmark yields have declined.  The PMIs suggest that regional economy may have lost a bit of momentum in Q3, though it continues to operate at a high level. In the coming days, the Eurostat will report July retail sales (likely fell) and industrial production (likely bounced back after sharp 0.6% decline in June). "  

"The second component is the ECB's next policy step.  We had expected that the ECB would take advantage of the new staff forecasts to announce that it will extend the asset purchases next year but at a slower pace.  However, the strength of the euro, which briefly traded above $1.20 last week (and approached the 50% retracement objective of the depreciation that began in mid-2014-~$1.2165), has increased the risk that the ECB waits a little longer to announce its decision.  It must ultimately extend the purchases or make a potentially destabilizing hard stop (except for the reinvestment of maturing issues that are estimated to run at a little more than 10 bln euros a month)."  

"Instructing the relevant committees to review the issue, in the context of a lower inflation forecast would be seen a dovish development, but we don't think it changes the outcome.  There is two aspects of the policy that is important to investors, assuming that no new assets are added to the mix or taken away (though we would not rule out stopping buying ABS, which has seen low and diminishing interest):  the length of the extension and the amount to be purchased."     

"The current extension was for nine months (until the end of this year).  We suggest a six-month extension now maximizes the flexibility that policymakers need.  It would also cover the period of the run-up to the Italian election next spring (the date and rules have yet to be determined)."   

"At its peak, the ECB was buying 80 bln euros of assets a month.  This was reduced to 60 bln since March.  If the ECB were to reduce the purchases to 40 bln euros a month as a majority of the Reuters poll would have it, this would imply the ECB would be expanding its balance sheet for nearly all of 2018.  This is too big a commitment, which despite the program's flexibility, will be seen by such an announcement.  We suggest that a 30 bln reduction (to 30 bln euros) would maximize the ECB's flexibility.  Having made a 30 bln euro adjustment, it could do so again in after H1 and end the purchases.  On the other hand, if needed it could taper further at mid-year.   It would also allow continued broadly adhering to the capital key, which is an important principle in Europe beyond its use in QE."   

"The third-factor investors need to grapple with is the euro and market psychology.  After moving above $1.20 on August 29, the euro could not sustain the momentum, and it has slipped lower.  The disappointing US core PCE deflator and employment growth saw the euro make another run at $1.20 before the weekend (~$1.1980) before selling off on reports of the ECB's cautiousness next week.  The euro finished just off session lows.  At the start of this year, many were concerned about the extreme long dollar positioning.  Dollar sentiment seems as extreme now but in the opposite direction, and the euro is the un-dollar of choice."