This Thursday, the governing council of the European Central Bank is widely expected to cut its overnight rate by 50 bps to 1.5 percent. Typically, expectations for rate decisions are already priced in on exchange rates. However, we expect the EUR/USD to be very volatile once Jean-Claude Trichet discloses more details about the ongoing slowdown in the euro-zone economy.
Recession in the Euro Area May Be Longer than Expected
Over the last few weeks, with the release of a series of economic indicators for the euro-zone, something has become very clear. Europe is in the worst recession since the inception of the euro as an accounting currency on January 1999. European stock markets have been selling off (chart below) and the euro economy contracted by a record 1.5 percent in the fourth quarter of 2008, the third straight quarterly contraction, according to estimates published by the Eurostat. However, was not always clear the financial storm that started in the U.S. subprime market would one day reach Europe. Initially, many European Union policy leaders thought the financial crisis would be confined to the United States and the European Commission and the ECB were slower to act than the Federal Reserve and the U.S. Treasury. However, EU politicians were wrong and the Euro zone economy is now succumbing to tight credit conditions. In fact, Jean-Claude Trichet, the ECB president, could not be clearer when he gave a speech to the European American Press Club just two weeks ago. “The current turbulence poses a serious challenge to the financial system as a whole and to economic policy-makers and regulatory authorities around the world”, he said. “The euro area and our 329 million fellow citizens can count on the ECB to take the necessary decisions” he added before the end of the conference. However, at DailyFX we think that lower interest rates may not be enough to prevent the region from falling into a long-term recession.
European Stock Markets
Forecast for EUR/USD Ahead of the ECB Rate Decision
In general, expectations for rate decisions are already priced-in on exchange rates and this Thursday’s ECB rate decision is not an exception. Moreover, it is extremely difficult to trade interest rate decisions since the currency market becomes very volatile when the overnight rate level is announced. Even so, at DailyFX we think traders should be prepared to trade this rate decision because the ECB is likely to surprise the market with a dovish statement which may impact investor’s expectations for future interest rate decisions. Obviously, Jean-Claude Trichet will not say that the ECB will cut the overnight rate to zero percent because this would seriously reduce his space to maneuver. However, he may acknowledge that lower interest rates are needed to prevent the euro-zone from falling into recession and this admission only by itself could be enough to shift investor’s sentiment against the euro and bring the EUR/USD exchange rate under downward pressure.
Antonio Sousa is a Chief Strategist for DailyFX.com at FXCM in New York City where he performs global economics research and develops systematic trading strategies. To contact him please e-mail firstname.lastname@example.org .