EUR: All set for a dovish taper from ECB - HSBC

With little incentive for the ECB to sound hawkish at its upcoming policy-setting meeting, the balance of risks point to some modest downside EUR risks, but it is hard to see President Draghi delivering anything profoundly market moving, according to analysts at HSBC.

Key Quotes

“Instead, we see scope for EUR-USD to drift lower to the 100-day MA at 1.1655 and the 6 October low of 1.1619. EUR-GBP may rise somewhat, largely on the back of GBP which looks out of sync with recent rate developments and a more overtly ‘dovish’ BoE hike.”

“The question for the EUR is whether the ECB surprises to the hawkish or dovish side.  According to Bloomberg, the consensus expectation is that the ECB will extend its QE programme for nine months at a run-rate reduced from EUR60bn per month to EUR30bn. We find it hard to see where the hawkish surprise might come from. Even if the run-rate were trimmed to say EUR20bn or EUR25bn, we would not expect it to have a lasting bullish impact on the EUR. Similarly, if our economists are correct in projecting a EUR40bn run rate for six months, we would not expect it to cause acute EUR weakness. Whatever the number, the signal is clear: the ECB is moving towards the exit from QE but at a gradual pace.”

“The more significant scope for reaction comes from the tone of the ECB’s communication. There is little chance of a hawkish surprise on the forward guidance front. The commitment to keeping rates low “well past” the end of the bond buying programme will almost certainly be retained, we believe. On 12 October, President Draghi said this “well past” statement is “very, very important”. Another possible, but unlikely, hawkish surprise would be a definitive end date for the QE programme. We believe it is more likely the programme will remain open-ended even if the pool of available bonds to buy is set to get rather shallow during 2018.”

“There is perhaps greater scope for a dovish surprise in terms of tone which will depend on how “dovish” a taper the ECB wants this to be. Our economists believe inflation has peaked in the Eurozone for now and may fall back to 1% by the end of the year on the back of base effects from higher energy prices last year. HSBC’s inflation projection for 2018 is a mere 1.2% YoY. Low inflation at the start of 2018 may also temper wage gains during the collective bargaining negotiations. Draghi noted recently that the ECB “sees some progress on wages but not enough.” If similar sentiments feature prominently in the press conference then the EUR could wilt somewhat, despite the taper.”

“However, there is little chance the ECB president will exacerbate such downside EUR pressure with any expression of discomfort with the EUR’s level. When EUR-USD traded above 1.20, there were some expressions of disquiet within the ECB’s minutes that the exchange rate might overshoot in the future, but it has retreated from these levels. The trade-weighted EUR may be closer to its recent highs than EUR-USD, but we do not expect the exchange rate to be a key feature of the press conference discussion.”

“Beyond the ECB meeting, there is little to ruffle the EUR. The currency has proven largely indifferent to political risk in Spain and the ECB meeting is about to lay out the likely trajectory for policy over the next year. Tactically we see some modest EUR downside risks, but mediumterm this currency is likely to trade largely sideways.”