The euro awaits the ECB as hopes direct elsewhere (Daily analysis 10.12.2020)

A benign risk sentiment sours ahead of key events, the ECB meeting and EU summit. Hopes for a fiscal deal started to fade away as partisan disputes escalated. Equities trade in the red and the greenback's rout has eased.

The EUR/USD pair slipped below 1.21 mark. The pound sterling continues to trade jittery as the Johnson – von der Leyen meeting disillusioned hopes for a trade deal breakthrough. A new deadline was set for Sunday, yet it concerns the future of the negotiations, not the deal itself. Therefore, the talks may continue next week. The GBP/USD pair erased its advance towards 1.35, and it is traded around 1.3350.

As regards to the key issues, the only breakthrough that was achieved concerns the Polish and Hungarian spat with the EU on the rule of law mechanism. The EU Budget compromise should be confirmed at the Summit, which has already pushed the EUR/HUF and the EUR/PLN lower.

A day of recalibration

Expectations are extremely high for today's ECB meeting as in October the ECB president Christine Lagarde committed to 'recalibration' of all instruments. Most probably this means an extension (until the end of 2021) and expansion (by at least 500bn EUR) of emergency asset purchases combined with stepping up the pace of asset purchases. Secondly, the ECB is set to extend the current accommodative policy with TLTROs (Targeted longer-term refinancing operations). The ECB might also start buying corporate bonds issued by fallen angels and tune interest rate tiering so that negative interest rates would become less of a burden to the banking sector.

Although the Governing Council believes the PEPP (Pandemic Emergency Purchase Programme) and the TLTRO match perfectly to pandemic conditions, ECB Chief Economist Philip Lane stated that "it is important not to infer that we are only looking at two programs". Therefore, a rate cut is not completely off the table. The common currency's strength will be a major focus for the markets. The EUR/USD pair has advanced sharply recently and now trades close to 1.21. Regardless, a trade-weighted exchange rate has been mostly stable, albeit on elevated levels. Opting for a rate cut or suggesting it might be used in the nearest future would harm the euro while indicating that pledged size of purchases means a maximum that most likely will not be used would be euro positive.

Conotoxia research team