ECB tapering report caused some short-lived weakness in the euro - Rabobank

In a relatively quiet market ahead of the FOMC decision today, a Reuters report on ECB tapering caused some short-lived weakness in the euro, notes the analysis team at Rabobank.

Key Quotes

“Citing ‘six sources’, Reuters reported that the ECB may want to keep the option open to extend purchases again in 2018 – highlighting the differences of opinions of the Council’s hawks and doves. This briefly sent EUR/USD down around 30pips, from around 1.199 to near 1.196, though the euro’s weakness did not last.”

“Although much detail is lacking, the report lends some support to our view that the ECB will opt for a flexible "decision by (quarterly) meeting" approach, whereby it emphasises the symmetric nature of the adjustment (i.e. purchases can also be raised again) and where the choice of the first adjustment (say, to EUR 40bn/month as from January) gives some idea of the size of future adjustments. Speaking of the adjustments, we have slightly refined our expectations of the timing and size of the cuts. We forecast QE to be tapered off in 3 steps of EUR 20bn each, one in December (effective January), one in March, and one in June – to match the meeting dates accompanied by new projections.”

“The alternative approach of a pre-committed pace and duration of the programme (say, a ‘one-off’ reduction to EUR 20 or 30bn a month intended to run at least to June or September) would be less flexible. The least likely, we believe, is a committed phase-out with a set end date (i.e. “we will be done by xx-xx-xx”). This last option would obviously be preferred by the hawks, who already grudgingly agreed to extend QE last December – and possibly with the condition that this would also be the last extension.”

“We believe that our base case of gradual and flexible adjustments would be more palatable to the hawks, rather than another commitment to extend for the umpteenth time –even if this is at a slower pace–, while also being acceptable to the doves. Admittedly, this approach comes with the risk that once the next adjustment is made (say from EUR 40bn to 20bn in March), the market will simply extrapolate this and infer that the program will be phased out completely by July 2018 at the latest (assuming a 20bn cut each quarter). If, along the way, such market expectations lead to unwarranted tightening, the ECB still has the option to switch to the second alternative (i.e. committing a longer period of steady purchases) at a later stage.”