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The Fed, the Reserve Bank of Australia, the Bank of Canada and the Bank of England have already lowered interest rates during the past weeks. Now, it's time for the ECB to act.
It should be recognized that the European regulator was in a quite difficult position, since it had almost worn out the supply of funds that could support the eurozone economy in the context of the coronavirus epidemic.
The ECB's deposit rate even before the outbreak was at -0.50%. In addition, the regulator already buys monthly bonds worth € 20 billion, although it has moved away from the peak QE of € 80 billion at the same time.
These measures have failed to accelerate economic growth and inflation in the currency bloc. Moreover, the last indicator barely exceeds the 1% mark, remaining far from the ECB target of 2%.
So, what options do the ECB have?
1. Passive position
The regulator may recognize that additional monetary stimulus will not provide any support to the Eurozone economy, and will prefer to take a wait-and-see attitude, trying to push the national governments of the region to action.
Theoretically, such a move could please the "hawks" of the ECB Governing Council and support the euro. However, it will demonstrate a lack of coordination in Europe and undermine the confidence of investors, with the result that the euro risks weakening.
The probability of such a scenario is estimated to be average. And although the Central Bank understands that the new incentive measures will have only a very limited impact on the economy of the currency bloc, it is unlikely to want to stay on the sidelines and not assume any responsibility.
2. Lower deposit rates by 10 basis points
If the deposit rate drops to -60 basis points, it will hit European commercial banks even more and is unlikely to be beneficial. It will also make investors think about the limited capacities of the ECB.
In this case, the euro may weaken even more, and such a scenario looks most likely, since it meets market expectations.
3. The increase in QE volumes
In an attempt to fulfill its responsibilities in supporting the eurozone economy, the ECB can do whatever it takes, including increasing bond purchases. This will weaken the euro, especially if the rate is raised to € 50 billion per month or more.
However, there is a chance for a subsequent rebound in the euro, as some market participants may regard such ECB measures as a harbinger of fiscal stimulus by national governments.
Nevertheless, such a scenario is unlikely, since it is likely to meet fierce resistance from the "hawks" in the ECB.
Thus, the ECB still has options, but all of them are obviously losing for the euro, at least in the short-term.
HSBC strategist, Dominic Bunning, said that a sharp rally in the euro during the recent period of risk aversion can soon be replaced by a decline.
According to him, the strength of the single European currency is a short-term change in positioning: investors withdraw from carry-trade transactions in which the euro was used as the funding currency.
An expert said that the euro will turn down as soon as the liquidation of positions ends. At the same time, forced exits from carry trade transactions should not be confused with a situation where market participants are looking for security for their investments. Although it can be assumed that EUR/USD may continue to rise, there are already some signs that the rally is starting to fade. The signs of a reversal can be seen and look forward to returning to 1.10.
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