Could ECB fuel rally in stocks as it tries to stem euro strength?

Reports yesterday that the central bank forecasts are said to show more confidence in economic outlook has apparently helped to halt the selling for the EUR/USD, with some investors now anticipating a not-so-dovish ECB after all.

However, it is not just the euro that bounced yesterday. The likes of the GBP/USD, AUD/USD, gold, as well stock indices and crude oil also rebounded, suggesting that the EUR/USD’s recovery may have been due to a rebound in risk appetite than just expectations for a somewhat less dovish ECB.

I actually think that the ECB will be very cautious and wouldn’t want to give the wrong signal to the market. It will try its best to talk down the euro, and the only you can do that is by talking up the prospects of more stimulus.

As investors awaited the outcome of the ECB meeting, the euro strengthened a little this morning, with the EUR/USD closing in on 1.1250, while European stocks fluctuated. The ECB is widely expected to keep interest rates at zero and QE unchanged, when it publishes its decision in the monetary policy statement at 12:45 BST. Investors will then be closely monitoring comments from President Christine Lagarde at the ECB press conference at 13:30 BST. In particular, they will be watching for any hints on whether the ECB would start laying the groundwork for more QE in an effort to prevent the euro’s strength from slowing the recovery.

The euro has been rising against the dollar for the last few months, raising fears that this may hold back exports and drag down prices. Meanwhile fears over a second wave have risen with a sharp increase in the trend of new cases in Spain and France, as well as Portugal and a few other places in the eurozone. Another wave of lockdowns would destroy the tepid recovery on the continent and as such, governments appear to be very reluctant to introduce wide-ranging measures like they did at the height of the first round. Governments are now favouring local and targeted measures. Here, the UK is also switching to the “rule of six” to streamline guidance and to reduce infections, as it tries to contain the new pick up in infection rates.

Whether the strength of the euro presents a major concern for the ECB and whether it will be able to stem its rise remains to be seen. The EUR/USD’s downside may be limited in any case because of the ongoing dollar weakness. What’s more, any dovish messages are likely to boost European stocks, and the resulting risk-on reaction may in turn weigh on the safe haven US dollar further, thus diluting the negative impact it may have on the EUR/USD. Thus, a dovish ECB is likely to cause a cleaner move for the likes of the DAX than the EUR/USD.

EUR/USDSource: and ThinkMarkets

Source: and ThinkMarkets