ECB Rate Decision (12:45 GMT; 07:45 EST)
Expected: No Change, 4.00%
Previous: No Change, 4.00%

ECB Press Conference (13:45 GMT; 07:45 EST)
Expected: Hawkish
Previous: Hawkish

What Are The Markets Facing?

On Thursday, two major central bank decisions are scheduled to be released, and the results could have a large impact on the markets, particularly in FX. Since we’ve already covered the Bank of England rate decision in this week’s Trading the News report, we’ll focus on the European Central Bank. The ECB is forecasted to leave rates steady at 4.00 percent, but they are perceived as holding a hawkish bias as recent inflation estimates show CPI rocketing above the bank’s 2.0 percent ceiling to 3.2 percent in January. Indeed, there is little doubt ECB is dealing with rampant consumer price growth, but economic conditions have started to deteriorate significantly according to reports released since the bank’s last meeting. The unemployment unexpectedly ticked up to 7.2 percent in December from 7.1 percent, while consumer confidence in January fell to an index reading of -12 from -9. It’s not entirely surprising to see sentiment deteriorate given the dim growth prospects for 2008 and the negative impact of higher energy and food costs on disposable income, but unfortunately for the Euro-zone economy, this has started to translate into weaker spending as retail sales unexpectedly slipped 0.1 percent in December. Furthermore, the services sector slowed more than expected in January as PMI fell to 50.6 from 53.1, marking the lowest reading since 2003. Nevertheless, the deal-breaker for rate expectations after this meeting depends on whether or not Trichet will remain hawkish in his subsequent policy statement: If the ECB President keeps his focus on maintaining “price stability” or goes so far as to note the phrase “strong vigilance” (an excellent signal of impending policy action), the markets will judge that the bank will stay neutral through the first half of 2008. However, if the policy statement focuses more on the downside risks to growth, the markets may consider the possibility that Trichet’s monetary policy tightening cycle is done for good and that rate cuts could loom on the horizon.

Bonds – 10-Year German Bund Futures

Bunds have pulled back from the 117.50 level, but Fibonacci support at 117.05 has prevented sharper declines, and with risk aversion propping fixed income markets globally, the daily charts still look bullish. However, the failure of the contract to break above resistance and the extremely bearish looking candle from January 22 signals that Bunds may be just waiting to tumble. Event risk from the ECB’s meeting could trigger such a move, as speculation that Trichet will issue markedly less-hawkish rhetoric may be proven incorrect.

FX – EUR/USD

Although the ECB is expected to announce that they will maintain interest rates at 4.00 percent on Thursday, the decision still carries significant event risk for the EUR/USD pair. It is widely known that ECB President Jean-Claude Trichet is a staunch inflation hawk who continually reminds the markets that “price stability” is the central bank’s primary concern. With flash estimates for January CPI at a whopping 3.2 percent, Trichet’s bias has recently had some traders speculating that a rate hike may be in store. However, the recent fundamental economic data emanating from the Euro-zone has showed the region’s economy may not decouple from the US to the degree that the ECB has maintained. Therefore, any hint by the transparent Trichet that his stance is becoming dovish could send the pair tumbling. Traders have already started to hedge toward an ECB easing in the near term, which has sent the pair below its 50 SMA. Many feel that the ECB won’t be able to ignore the obvious global economic slowdown and the long term effects that it is posed to have on their export driven economy. Unless the ECB makes a strong reaffirmation of their hawkish stance, we may see the pair re-test 1.4352, the 38.2% Fibo level of the 1.3371-1.4961 rally, as it did on January 22. There is a small possibility that the ECB could cut rates, which would assuredly send the pair in a free fall. However, the ECB’s recent admonishments of the Fed for cutting rates and panicking make that highly unlikely.

Equities – Xetra DAX Index

The recovery of the Xetra DAX Index from the January lows ran into resistance from the 38.2 percent fib retracement level of the drop from 8,117.79 – 6,384.40, and US recession concerns helped send the index tumbling on Wednesday. However, with support below at 6,680/90, subsequent declines have been limited for the time being. However, commentary by ECB President Trichet could shake the index up on Thursday, as a pronounced focus on downside risks to growth could lead the DAX to fall through support towards 6,500. On the other hand, if the central bank remains confident that a slowdown in global growth will not impair the Euro-zone economy significantly and that a rate cut will not be needed in the near term, the index could bounce towards 7,000. Nevertheless, broad risk aversion trends remain the primary driver of many stock markets – including the Xetra DAX Index – so traders should beware of volatile price action in Asian markets the evening before.

Terri Belkas is a Currency Strategist at FXCM.