Two central banks are due to set the monetary policy this week – the European Central Bank (ECB) and the Bank of Canada (BOC). Out of the two, the ECB meeting and press conference are highly anticipated, as expectations grew that the central bank would react to the sharp drop in the core inflation.
The Euro’s strength is another issue to address. While the ECB will never admit that it targets a certain exchange rate, it is known that it is always looking at the euro-dollar rate as a higher Euro weighs on inflation.
More Easing from the ECB?
The week has a slow start as the Labor Day in the United States is responsible for low volatility levels. Therefore, after the London closing today, expect slow ranges and little or no movement on the currency market.
No first-tier data on Tuesday as well. Currency traders will look for direction, once again, at the stock market.
Wednesday the BOC sets the monetary policy and releases its statement. The Canadian Dollar is one of the strongest performers as it gained against the U.S. Dollar during the pandemic. Relative stable oil prices made it easier for BOC monetary policy decisions, and this week the bank is expected to hold its rate unchanged.
The main event of the week comes a day later. On Thursday, the ECB interest rate and the press conference will mark the end of the summer for currency traders. The ECB must react to the sharp drop in core inflation, and the only question is what it will choose to do.
The Euro area’s recovery seems to lag the momentum seen in the United States. Also, a quick look at financial conditions in the Euro area and in the United States reveals more tightening in Europe – partially explaining the Euro’s strength.
Euro’s strength is one of the problems on the ECB’s table. The common currency gained across the JPY, the USD, the GBP, and held its value against other G10 currencies.
With inflation threatening to break below the zero level, the ECB is forced to react. The problem is that no one sees what the appropriate reaction would be? How to ease further when the interest rates are already at the lower boundary, and quantitative easing is already in place?
Christine Lagarde and the Governing Council must show flexibility and ingenuity. Without a bold move, the risk is that the market will push the EURUSD rate way beyond 1.20, making it difficult for the ECB to fulfill its price stability mandate.