BMO: be fully prepared for the ECB
Analysts at BMO have outlined different scenarios for the ECB meeting on Thursday outcome and EUR/USD reaction. The reference EUR/USD rate is $1.3500.
According to BMO, the ECB may take 2 types of measures – corrective and preventative.
Corrective measures are any aggressive actions taken to offset deflationary pressures which have actually emerged. The possibility of such measures this week is estimated to be 25%.
1. Bypass the OMT and buy core or peripheral bonds unsterilized
Reaction in EUR/USD: minimum 100 pips lower on the kneejerk, up to 300 pips lower over 1-3 sessions.
2. Cut the deposit rate by 25_bps to -0.25%
Reaction in EUR/USD: minimum 300-500 pips lower over 1-5 sessions.
Preventive measures are actions taken to help keep CPI risks ‘firmly anchored’ over the medium-term and prevent disinflationary expectations. The possibility of such measures this week is estimated to be 50%.
1. Cut the benchmark (repo) rate by 5-25_bps
Reaction in EUR/USD: very minimal, up to 75 pips in the case of a 25bps cut but probably less. Bond rates are already close to 0, look to buy EUR/USD in the $1.3420/45 area.
II. End sterilization of the Securities Market Program (SMP) holdings (approx. 170B euro worth)
Reaction in EUR/USD: similar kneejerk to the impact of a 25 bps rate cut (50-100 pips lower). This is partially priced in and LTRO repayments offset the effect, look to buy EUR/USD in the $1.3420/45 area.
III. Announce a new LTRO (up to 3 years or more)
Reaction in EUR/USD: size-dependent, 3-year LTROs I and II knocked 1000-1200 pips off EUR/USD over 2.5 months. Take-up likely to be small as banks repay old LTROs, spreads may narrow forcing EUR/USD up, look to buy EUR/USD in the $1.3420/45 area.
IV. Announce a program to buy private sector loan pools from commercial banks
Reaction in EUR/USD: depends on size and whether or not the actions are sterilized. Credit spreads and bank shares might rally, forcing euro to do the same if the program is unsterilized. Look to buy EUR/USD in the $1.3450/70 area or higher if the program is unsterilized.
Conclusion: Preventive measures are more likely. This could be a good week to start positioning for medium-term EUR/USD downside.