Following the October ECB meeting we suggested that the ECB would cut the depo rate by 15bp and deliver more QE at its December meeting. At that time our call was out of consensus with forecasts for a 10bp cut, but since then the money market has moved toward pricing in almost fully a 15bp cut.
We expect the ECB to cut the depo rate by a further 15bp, but we think that in an effort to encourage a more positive market reaction, the odds of a 20bp cut are equally likely. The EONIA curve has been moving deeper into record negative territory with the market now close to fully pricing in a 15bp depo rate cut. The need to be more aggressive than 20bp has been reduced by the prospect that the Fed will begin policy normalisation with a likely lift-off at the December 15/16 FOMC meeting.
It is clear that the FX channel is a key transmission mechanism for looser policy to allow the ECB to meet its inflation mandate. A key driver for EUR weakness, and thus looser financial conditions, has been the divergence in Fed and ECB expectations. Note last week ECB’s Praet pointed to the recent improvement in financial conditions as incorporating “expectations about policy actions” not only in Europe but also everywhere else.
EUR/USD continues to post lower-lows and we should continue to see this heading into year-end as ECB easing and Fed lift-off in December helps to maintain a sell on rallies stance on EUR/USD.
We still see EUR/USD ending the year closer to parity than 1.05.
