ECB Announces Interest Rates (07:45 EST; 11:45 GMT)
Expected: 4.00%
Previous: 4.00%

How Will The Markets React?

On Thursday, the European Central Bank is expected to announce that they are leaving their benchmark overnight lending rate at 4.00 percent for the second consecutive month. Indeed, a steady hand is warranted, as June inflation reports showed CPI holding below the ECB’s 2.0 percent target at 1.9 percent while estimates for the July reading show the potential for an easing to 1.8 percent. Nevertheless, the central bank is likely to remain concerned that their previous policy actions (two hikes since the beginning of the year) have had little impact on the Euro-zone economy. Though investor confidence has taken a hit, consumer sentiment went unchanged in July while the unemployment rate was revised down to 6.9 percent – the best reading since 1993. Moreover, the manufacturing and services sectors remain resilient, as domestic and foreign demand support the industries. Money supply growth is likely to keep the ECB hawkish as well, with M3 surprisingly jumping 10.9 percent in June from a year earlier. While the merits of money supply figures as an inflation gauge are mixed, the data will remain of concern to the ECB. As a result, bond markets are pricing in a 25 basis point hike in September to 4.25 percent. However, with no physical meeting being held this month, there will only be a press release which will likely contain only a neutral, non-policy statement. Furthermore, without ECB President Jean-Claude Trichet’s regularly scheduled press conference, the central bank may not have the opportunity to articulate their hawkish bias with the phrase “strong vigilance”, which will create the potential for a cut back in policy tightening expectations.

Bonds – 10-Year German Bund Futures

Bond futures have shown significant strength through the past two months, with the recent anti-carry shakeout leading the 10-year future to its highest since early May. However, the contracts pulled back sharply today after an attempt to take out the 112.97 level. This price action is somewhat bearish for bunds, and a break of 112.53 would confirm the end of the recent uptrend, with declines targeting 111.70. However, if the ECB fails to signal an overtly hawkish bias in their press release on Thursday, Bunds could take out resistance to take aim on 113.90, especially if risk aversion trends prevail. However, the mere mention of the term “strong vigilance” will set the stage for September rate hike, and could propagate the aforementioned break lower for bunds.

FX – EUR/USD

Indecisive EURUSD price consolidation leaves ample room for a move in either direction on tomorrow’s ECB rate decision, with recent declines leaving a euro-bearish bias through the near term. The central bank is widely expected to leave rates steady at 4.00 percent, but ECB President Jean-Claude Trichet’s press conference commentary is typically the bigger driver of price action for EUR/USD. However, this time around, the meeting will be conducted via teleconference and only a press release will be issued following the rate announcement. This release is likely to contain only a neutral, non-policy statement, which will leave the markets wondering what the ECB’s next move will be, especially as fixed income markets are pricing in a September hike to 4.25 percent. As a result, EUR/USD could break down to the 1.3600 level, as the lack of the term “strong vigilance” may leave traders speculating that another round of policy tightening will be delayed until later in the year. On the other hand, the insertion of the hawkish phrase could lead EUR/USD to surge higher.

Equities – Xetra DAX 100 Index

Equities around the world have tumbled over the past two weeks, and the German Xetra DAX index is no exception. The past few days have found the benchmark index consolidating in a nearly 200 point range, but if the European Central Bank manages to find a way to convey that they will hike in September, the DAX could tumble to the May 11 low and Fibonacci support near the 7,300 level. However, since the ECB policy meeting will be conducted via teleconference and will not conclude with ECB President Jean-Claude Trichet’s regularly scheduled press conference, there will be limited opportunity for the bank’s hawkish bias to be made clear. As a result, global equity market trends will likely prevail, but nevertheless, traders should be aware of the event risk presented by the ECB meeting on Thursday.

Terri Belkas is a Currency Strategist at FXCM.