21.01.202113:23 Forex Analysis & Reviews: ECB to launch new program to support COVID-hit eurozone economy

Exchange Rates 21.01.2021 analysis

Investors are focusing on the first ECB meeting of 2021. Most experts do not expect to hear anything new or important from policymakers after the regulator announced the extension of the asset purchase program in December.

Nevertheless, one should not deny the importance of the current meeting, since the central bank has an important task to do. It must decide how to stimulate the European economy severely hit by the coronavirus pandemic.

Growth forecasts for the economy are getting gloomier. Europe and the US will release their preliminary manufacturing and services PMIs for January on Friday. Europe's business activity results may turn out to be even worse than the possibility of lockdown extensions in the US.

As much as the ECB wants to help the economy, its options are limited. The refinancing rate is at 0%, while the deposit rate has long been in the negative zone. The Pandemic Emergency Purchase Programme (PEPP) was launched in 2020. It has been expanded twice. In addition, the ld Targeted Longer-term Refinancing Operations Trogram (TLTROS) modified last year is still running.

Given the circumstances, it is not easy to create a new mechanism that will allow the economy to breathe a sigh of relief. But Christine Lagarde and her colleagues still have to come up with something.

Recently, there have been rumors in the financial markets about the upcoming launch of a new ECB program. Of course, it will not be new exactly, since a similar one has been operating in Japan for the last 4 years. It is called Yield Curve Control (YCC).

According to the Japanese program, the regulator is targeting the yield on 10-year government bonds at 10 basis points. Clearly, the Japanese central bank maintains tight control of bonds and the yield rarely goes beyond 0.1% .

It will be difficult for the European regulator to repeat the Japanese experience, since the eurozone is a different and more complex structure. There are a lot of government bonds here. It will be hard to control everything. Therefore, the program is likely to be somewhat different.

Recently, financial experts have noticed an unusual course of events in the European stock market. Italian government bonds ignored the political crisis in the country. The spread between the German and Italian 10-year bonds has hardly changed, remaining at around 110 basis points. Most likely,this is all due to the ECB's intervention.

We can assume that the ECB could launch a program to control the yield curve, that is, to control the government securities spread. All that has left is to make an announcement. That is why today's meeting is so intriguing.

As for the euro, it has been rising before the event. Strong risk appetite and a weaker US dollar provide support to the euro.

From a technical point of view, the pair is now balancing near the 1.22 liquidity zone. Both bears and bulls will try to gain control of the 1.207 level.

In the long-term, most forecasts are based on the fall in the US dollar index. However, not all investment banks are sceptical about it. For example, ABN Amro has once expected the greenback to decline and the euro to advance to 1.30. Nowadays, they have abruptly changed their stance. They now project the euro to drop to 1.10 at the end of 2022. By the end of this year, the euro should sink to 1.15.

As for the US dollar index, they revised their outlook from negative to moderately positive.

What is the reason for this? According to analysts, a faster recovery of the US economy, and a less dovish Fed with higher yields in the country should boost the US dollar. The problem of fiscal aid has been almost solved, the money is about to float into the American economy. Against this backdrop, ABN Amro raised its forecast for US GDP for 2021 to 5.8% from 3.2%.

Natalya Andreeva,
Expert Specializat
Grup InstaForex © 2007-2021
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