On Thursday, January 21, the ECB's interest rate decision will be published and also we’ll hear what Christine Lagarde has to say at a press conference as European countries extend restrictions and the economy is again threatened with the recession. Additionally, the market will see if the ECB will address the euro exchange rate.
In the summer and early autumn, it seemed that the winter or the beginning of spring would bring a thaw and the epidemic situation would be under control. Meanwhile, we continue to see an increase in infections and fatalities with new restrictions being expanded. Nonetheless, as the Eurozone enters its third round of restrictions, financial markets already understand the European Central Bank's reaction function, which greatly reduces the need for shocking action.
What can be expected from today's ECB decision?
According to expectations published by Bloomberg, during the press conference, ECB President Christine Lagarde is expected to provide an update on the economic outlook for the Eurozone and highlight risks to the December forecast. The ECB's December forecast for Q1 is feasible only if restrictions are not more severe on average than in Q4 and end in the first three months of the year, i.e. before the end of March. While this is possible, our view (and that of epidemiologists) is that the emergence of a more infectious strain of the virus means tighter restrictions in the coming months rather than easing them, Bloomberg reports. The medium-term outlook is little changed. Vaccines will continue to facilitate a gradual unblocking of the eurozone economy in the second quarter and a rapid recovery over the summer is still anticipated.
What's next for the Euro?
The exchange rate of the main currency pair is still above the 1.2100 level. Recently, there was a verbal intervention from ECB representatives in the 1.2000 area regarding the overly strong euro. Since then, the statements have been more subdued. If the overly strong euro is mentioned again this time, the market may find the situation favorable to carve out a larger correction, perhaps towards $1.17-1.16.
One institution that is breaking out of the mainstream of a weak dollar seems to be ABN Amro. The bank forecasts EUR/USD to fall to 1.15 from 1.25 in 2021 and to 1.10 in 2022. At the same time, ABN assumes a rise in US bond yields, a less dovish stance by the Fed and the introduction of rescue packages for the US economy that will accelerate economic growth to as much as 5.8 percent in 2021.
Daniel Kostecki, Chief Analyst Conotoxia Ltd.
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