FX - EUR/USD: Trading the European Central Bank Interest Rate Decision

Trading the News: European Central Bank Interest Rate Decision

What’s Expected:

Time of release: 12/08/2011 12:45 GMT, 7:45 EST

Primary Pair Impact: EURUSD

Expected: 1.00%

Previous: 1.00%

DailyFX Forecast: 1.00%

Why Is This Event Important:

The European Central Bank is widely expected to lower the benchmark interest rate by another 25bp in December, and the decision is likely to weigh on the single currency as the fundamental outlook for the euro-area deteriorates. At the same time, it seems as though the ECB may look to expand its nonstandard measures as policy makers consider a two-year loan for commercial banks, and we should see the Governing Council carry its easing cycle into the following year as the slowdown in economic activity dampens the outlook for inflation. However, we may see the central bank endorse a wait-and-see approach for 2012 as European policy makers increase their pledge to address the sovereign debt crisis, and we may see President Mario Draghi strike a neutral tone for monetary policy as the committee upholds its one and only mandate to ensure price stability. Nevertheless, as ECB President Mario Draghi is scheduled to deliver the policy statement at 13:30 GMT, the initial reaction to the rate announcement could be short-lived, and we may see market volatility pickup going into the press conference as market participants weigh the outlook for monetary policy.

Recent Economic Developments

The Upside

The Downside

The stickiness in price growth paired with the pickup in trade may encourage the ECB to soften its dovish tone for monetary policy, and the short-term rebound in the EUR/USD may gather pace should the central bank talk down speculation for additional monetary support. However, the drop in confidence paired with the persistent weakness in the private sector may lead the Governing Council to curb its fundamental assessment for the euro-area, and the central bank may show an increased willingness to expand monetary policy further as the ongoing turmoil in the financial system drags on the real economy. In turn, dovish comments from the ECB is likely to spark a bearish reaction in single currency, and we may see the EUR/USD threaten the rebound from 1.3145 as the central bank turns increasingly cautious towards the economy.

Potential Price Targets For The Rate Decision

How To Trade This Event Risk

Speculation for another rate cut instills a bearish outlook for the single currency, but positive comments from ECB President Draghi could set the stage for a long Euro trade as market participants weigh the prospects for future policy. Therefore, if the central bank talks down expectations for additional monetary stimulus and conclude its easing cycle in 2011, we will need a green, five-minute candle following the announcement to establish a buy entry on two-lots of EUR/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will generate our first target. The second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to protect our profits.

On the other hand, the ongoing turmoil in the financial system paired with the heightening risk of a double-dip recession may lead the ECB to expand monetary policy further, and the central bank may looks poised to carry its easing cycle into the following year as it aims to stem the downside risks for the region. As a result, if we see a rate cut and/or an expansion in asset purchases, we will implement the same strategy for a short euro-dollar trade as the long position mentioned above, just in reverse.

Impact that the European Central Bank Interest Rate Decision has had on EUR during the last meeting

November 2011 European Central Bank Interest Rate Decision

The European Central Bank surprised the market and voted unanimously to lower the benchmark interest rate by 25bp to 1.00% as the region braces for a ‘mild recession.’ At the same time, ECB President Mario Draghi argued that the asset purchase program are ‘temporary’ as the Governing Council sticks to its one and only mandate to ensure price stability, and went onto say that central bank have lower its economic assessment for the region as the economic recovery deteriorates. It seems as though we will see President Draghi will continue to move away from the nonstandard measures as the asset purchase program comes under increased scrutiny, and we may see a growing rift within the ECB as the governments operating under the fixed-exchange rate system become increasingly reliant on monetary support. The rate cut spurred a bearish reaction in the Euro, with the EUR/USD slipping back below 1.3700, but the market reaction was short-lived as the exchange rate ended the day at 1.3813.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

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