Date: 06 Jul 2017

European Central Bank (ECB) Chief Economist Peter Praet may have spoken dovishly on Tuesday but that didn’t stop US bank Morgan Stanley writing on Wednesday that “EURUSD has started to correct its latest bull sequence from the April 1.0570 low, which is expected to take time but not move much on price. We would not hesitate buying into EUR strength should EURUSD break 1.1450.” Others disagree. France’s Credit Agricole CIB wrote on Wednesday that “in an environment, where monetary policy expectations are unlikely to rise further and where EUR denominated risk assets do not outperform their US peers at the same extent as seen before, it may be difficult for the EUR to attract further rising buying interest, especially as investors continue to run a sizeable long position. If anything, and in the short-term the risk could remain on the downside for pairs such as EURUSD.” Traders will have their own opinions but might wish to consider practicalities associated with the ECB’s current bond buying programme. When it comes to the ECB’s current programme of bond buying, that very programme at the heart of speculation about potential tapering as a start point for the withdrawal of some of the ECB’s monetary ultra-accommodation, it’s apparent that the ECB is already being forced to move further away from its “capital key” rule which links its government bond purchases to each nation’s size.

That rule is intended to ensure ECB stimulus is spread evenly across the euro zone. As Dutch Bank ABN AMRO wrote “From the ECB’s QE purchasing data over the month of June, we calculate that national central banks (NCBs) continue to buy less core public sector bonds than implied by the capital key. According to the most recent data, the respective Eurosystem central banks have undershot their targets for 6 months running for Finnish bonds, 3 months for German bonds and 2 months for Dutch bonds.” That under-buying, the Dutch firm feels “is a strong signal that the respective NCBs are running out of room in these countries’ bond markets, most likely because they are moving closer to the 33% issue(r) limit.” Consequently ABN AMRO wrote “the recent data reveals that ECB is forced to de facto taper its core country buys even before the QE programme’s potential deadline of December 2017” plugging the gap by the “over-buying (relative to the capital key) of Austrian, Belgian, French and Italian bonds.” That is enabling the ECB to keep to its plan of buying more than its prescribed monthly amount of 60 billion euro of bond purchases although, as ABN AMRO pointed out, “the constraints are becoming more visible and will intensify.” If the currency market perceives that practical considerations around the ECB bond buying programme are being co-opted by those at the ECB already inclining towards some degree of monetary policy accommodation withdrawal, euro bulls (EURUSD) might well feel re-energised.

Written by Neal Kimberley, External Currency Analyst.