Economy & ECB Fuel EUR Rally

EUR has been soaring higher over recent months as consistently strong data out of the eurozone, and a more constructive tone from the ECB have encouraged the market view that the ECB will be winding down its QE program sooner rather than later. At their summer meeting, the ECB said that decisions on QE would be made in the Autumn, leading most to anticipate an announcement at the September meeting. Consequently, COT data has displayed a significant build in long positioning which reflects the shift in tone and the sizeable rally in EUR.

The market has had a tricky few years in terms of gauging ECB action and has been caught offside quite a few times. The ECB similarly have been left red faced on a few occasions when the market has punished the central bank for misleading signals. Is it possible that once again, investor expectations have run too hot ahead of an ECB meeting?

ECB Has Warned Against EUR Strength

The ECB has recently cautioned against the strength of the Euro noting is subduing impact on inflation with ECB chief Draghi voicing his concerns at the bank’s last meeting. Furthermore, Reuters recently reported ECB officials cautioning that QE tapering may be delayed in response to EUR strength. The shift in tone over recent weeks highlights the risk that the ECB will maintain current policy at the September meeting and instead wait until October to announce further tapering. While it can be argued that EUR strength is a function of the stronger economy attracting capital, rather than speculation of a shift in ECB policy, the bank will likely want to guard against any further appreciation at this point.

However, this meeting will still be important as the ECB will likely to use it to further talk down EUR and guard against strength which is delaying them from tapering. The wording will be important here as the ECB will need to be careful not to explicitly say that they will be announcing tapering in October, otherwise they will likely still suffer an FX overshoot similar to recent months.  This time around it is likely to be more of a hint than outright forward guidance.