FW: Maybank FX Insights - Low Probability Risk of ECB Disappointment – Any Impact? (Resend)

Low Probability Risk of ECB Disappointment – Any Impact?

§  The euro has fallen around 3% since early May when post ECB announcement, Draghi said policymakers would be comfortable adding economic stimulus measures in June given strong concerns over the strengthening of the exchange rate in the context of low inflation.  Key this Thursday would be surprises with regards to the action ECB will take rather than the actual move itself. Most are expecting now for at least and refi rate easing by 0.1 to 0.15ppts from current 0.25% and a negative deposit rate    (-0.10% or -0.15%).

§  Other measures could include a suspension of Securities Market Program (SMP) sterilization, QE purchases of private sector assets and ECB strengthening its forward guidance.  There could also be some probability on funding for lending program and small chance of another LTRO. For now we think at the current euro levels, the refi rate and negative deposit rates are partly priced in.  Further measures as well as some revision downwards to its inflation projections for 2014-2016 on top of deposit rate cut and credit easing could send a strong signal that would weigh heavily on the euro. No changes in the ECB inflation outlook for 2015-2016 could potentially lead to euro strength instead as markets interpret a no change in inflation outlook as a pause in any further policy moves in the future.

§  More recently, there have been some doubts on a one way short euro/dollar direction given concerns that market expectations may not be met. In addition, recent comments by former ECB Chief Economist Juergen Stark that an ECB rate cut would have limited impact as the rate tool has been exhausted. He sees no danger of eurozone deflation and sharp fall in prices. He has also highlighted that the low rate of inflation was largely due to a significant drop in prices of oil and commodities. He had also alluded that the euro is only relevant to monetary policy if it has significant impact on price developments and the common currency’s strength is a ‘temporary’ phenomenon that will recede with a change in US monetary policy. 

§  We briefly assess the impact of any ECB disappointment using the 2 May 2013 episode and assess the likely impact on Asian FX.  An ECB rate cut could lead to some Asian FX appreciation initially but if disappointing could lead to some weakness over the next few weeks based on the May 2013 episode. Our estimates show that a 1% appreciation in the euro tended to weaken the IDR, MYR, PHP by around 0.10% except for the SGD which appreciated.

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