What will happen with the euro after the ECB meeting

6 December, 2016

Morgan Stanley’s strategists believe that the ECB will keep rates on hold at this week’s meeting, but can expand its QE purchase program. But they consider different scenarios with various responses from the euro.

Potential scenarios and the reaction of the euro.

1. QE purchases extension for 6 months after March. This expansion is well priced in by the market participants, so, it wouldn’t be surprising for markets. The reaction of EUR/USD should be restrained. To extend purchases and leave an expectation in the market that they could extend again, the ECB should introduce some changes to its present program. Which kind of changes?

- The ECB may announce that it is not going to use the capital key to allocate purchases.This option will be positive for periphery countries of the Eurozone, but bad for the German bund. The reaction of the euro should be positive in this case. The ECB may not express itself explicitly, it can only hint that it is going to be flexible (in this case the euro’s reaction won’t be stormy). If the ECB is more explicit, the euro may react with some moves.

- The ECB can recourse to buying bonds below the deposit rate. This decision will be negative for the euro.

- The ECB may commit itself to changing the maximum limit on buying per issuer. This approach should be bullish for German bund curve. EUR/USD will fall, if there is a larger decrease in bund yields than US Treasury yields.

- The ECB may address the scarcity of bonds. If there is a rise in short end rates (it would dissipate fears over the bond scarcity), the euro may gather momentum.

2. The ECB announces the cut of its interest rate. This scenario is not expected by the market. If it is realized, EUR/USD should fall significantly.

3. ECB decides to extend its QE purchases by more than 6 months beyond March. This option is not expected by the market. EUR/USD will be poised to weakening.

4. ECB doesn’t change its policy stance. This approach will cause German bunds to rise substantially and push EUR higher.

5. ECB extends corporate bond purchases, but not government bond. Basically, in this case, the ECB will commit to the tapering of the bond purchasing program. This scenario is unlikely, and if it’s realized, it will be positive for EUR. 

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