Next Thursday the ECB (European Central Bank) is having its regular meeting and this one should be of particular importance for a number of reasons.
This is the first meeting after the summer holiday. During such periods of time, markets are ranging and nothing really happens from both a technical and a fundamental point of view.
However, once September starts, everything changes and this year seems to be no different: ranges all over the place, markets not even reacting to the Brexit vote, and no matter the news, support and resistance levels are holding on the bigger time frames.
As a central bank, the ECB has the mandate to keep inflation below or close to two percent. It means that it will move on rates and monetary policy in order to reach this target.
Last years saw inflation regularly missing the target and actually even dipping into negative territory as deflation took over the Eurozone. In order to fight that, a central bank is cutting interest rate and ECB did that as well.
Not only that the central bank cut the rates, but in doing that it moved them into the negative territory, surprising many analysts. Moreover, further steps were taken in order to adjust the monetary policy, like engaging into an ongoing quantitative easing program that is scheduled to stretch well into the 2017 and also buying private corporate debt.
Nevertheless, despite all efforts, the two main things destined to happen, a lower Euro and higher inflation, are simply not: euro pairs are being bought on each and every dip and inflation continues to fall.
This week saw the core year on year inflation rate dropping from 0.9% to 0.8% and this cannot be a positive sign for the ECB mandate or for the Euro as a currency.
Already speculation started about how the ECB will react to this drop in inflation and this is why the September meeting is so important.
The central bank has many tools that can still be used, like extended the QE program or making some changes in the capital key requirements. However, it is unlikely to announce something this coming meeting.
The reason for that is that more data is needed to see how the QE program that is running now is influencing lending in the Eurozone.
The idea behind negative rates and easy monetary policy is for commercial banks to lend more to businesses and people in order to earn an interest and not to park the overnight liquidities to the central bank’s vault.
But this is not happening as people tend to save more in a deflationary environment.
Having said that, even though the ECB is unlikely to announce new measures at the September meeting, it will definitely have a dovish tone. Draghi will emphasize the bank is remaining vigilant when it comes to inflation and will stress the readiness to act if conditions will not improve.
As a result, Euro should move lower across the board with the one favored to drop the most being the EURUSD.
We’ll find out if that is true in less than a week from now.