When the central bank last met in late October, ECB President Christine Lagarde said the it is looking to recalibrate all instruments at its next policy meeting. She warned that a contraction can’t be ruled out for the fourth quarter and there’s “little doubt” that more stimulus is needed as the central bank “will be looking at (recalibrating) everything.”
With less than 24 hours to its announcement, we can expect the ECB to, at minimum, raise its Pandemic Emergency Purchase Program by 400 billion to 600 billion and extend it to the end of 2021 or, possibly, even 2022. More asset purchases are likely as well, but most economists are not looking for a rate cut.
Central banks consider a number of issues when deciding how to change monetary policy, but the most important are usually inflation, unemployment, growth and the exchange rate. Inflation is running at a year-over-year rate of -0.3%, which is very low. Price pressures are starting to move higher, with gas prices rising to their highest level since March. In October, the ECB said risks are tilted to the downside, but with the start of vaccine distribution, the outlook is brighter. There’s still a high degree of uncertainty (a word used by the Fed), but recent data hasn’t been terrible. In fact, there’s been more upside than downside surprises in Germany’s reports. The expectations component of the ZEW survey, factory orders and industrial production rose more than expected. A brighter economic outlook from the central bank could drive the currency sharply higher.
However, the strong currency is a big problem. Since its last policy meeting, EUR/USD appreciated as much as 3%. It rose from 1.17 to a high of 1.2175 before pulling back this week. The central bank admitted it was watching the EUR/USD rate back in October when it breached 1.19. Now, it should be even more concerned, as a stronger currency offsets easing. Will its concerns about the exchange rate be enough to offset optimistic comments? Probably not. But given how much EUR/USD has run up over the past month, the pair is also begging for a correction.