Trading the News: European Central Bank Interest Rate Decision

What’s Expected:

Time of release: 11/03/2011 12:45 GMT, 8:45 EST

Primary Pair Impact:EURUSD

Expected: 1.50%

Previous: 1.50%

DailyFX Forecast: 1.50%

Why Is This Event Important:

Market participants see the European Central Bank maintaining its current policy in November, but the Governing Council may turn increasingly cautious towards the economy as the region faces an increased risk of a double-dip recession. A Bloomberg News survey shows 49 of the 55 economists polled forecast the ECB to keep the benchmark interest rate at 1.50%, but the central bank may continue to soften its hawkish tone for monetary policy as the slowing recovery in Europe dampens the outlook for inflation. In turn, we may see the ECB show an increased willingness to scale back the rate hikes from earlier this year, and the committee may carry its easing cycle into the following year in an effort to balance the risks for the region. However, as former Bank of Italy President Mario Draghi takes the helm, the central bank may merely reiterate the policy statement from the previous month, and market participants may overlook the rate decision as the developments surrounding the Greek referendum comes into focus.

Recent Economic Developments

The Upside

The Downside

The stickiness in price growth may become a growing concern for the ECB as it maintains its one and only mandate to ensure price stability, and the central bank may look to toughen its stance against inflation as it remains well above the 2% target. However, the slowdown in economic activity paired with the weakness in the labor market may encourage the Governing Council to adopt a dovish tone for future policy, and the central bank may take additional steps to stimulate the ailing economy in an effort to stem the risk of a double-dip recession. In turn, the EUR/USD should resume the reversal from 1.4246, and the exchange rate may threaten the rebound from the previous month (1.3145) as market participants increase bets for a rate cut.

Potential Price Targets For The Rate Decision

How To Trade This Event Risk

As the ECB is widely expected to maintain its current policy, trading the given event risk may not be as clear cut as some of our previous trades, but the market reaction could pave the way for a long Euro trade should the central bank look to toughen its stance against inflation. Therefore, if the Governing Council talks down speculation for additional monetary support, we will need a green, five-minute candle following the rate decision to generate 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 establish 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 order to preserve our profits.

In contrast, the ongoing turmoil within the financial system paired with the heighten risk of a double-dip recession may lead the ECB to scale back the rate hikes from earlier this year, and the central bank may carry its easing cycle into the following year in an effort to encourage a sustainable recovery. As a result, if the Governing Council curbs its outlook for growth and inflation, we will carry out the same strategy for a short euro-dollar trade as the long position laid out above, just in the opposite direction.

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

October 2011 European Central Bank Interest Rate Decision

As expected, the European Central Bank kept the benchmark interest rate at 1.50% in October, but said purchase up to EUR 40B in covered bonds while offering 12-months loans for commercial banks. Indeed, ECB President Jean-Claude Trichet held a cautious outlook for the region, stating that the ‘ongoing tensions in financial markets and unfavorable effects on financing conditions are likely to dampen the pace of economic growth,’ and talked down the risk for inflation as the central bank sees price growth slowing in the following year. As the slowing recovery in Europe dampens the outlook for growth and inflation, there could be a growing argument to scale back the rate hikes from earlier this year, and we may see the ECB carry its easing cycle into 2012 in an effort to stem the risk of a double-dip recession. The Euro tipped lower following the rate decision, with the EUR/USD slipping back below 1.3300, but the single-currency regained its footing throughout the day as the exchange rate closed at 1.3436.

--- Written by David Song, Currency Analyst

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

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