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Lockdowns still hurt but not so painful for the Euro zone

President of the European Central Bank Christine Lagarde
President of the European Central Bank Christine Lagarde addresses an event to launch the private finance agenda for the 2020 United Nations Climate Change Conference (COP26) at Guildhall in London. European Central Bank governors are expected to refrain from doling out fresh stimulus measures. PHOTO | AFP 

As of writing, it is Thursday 16th, five hours to the European Central Bank's policy meeting, which markets believe should have a fairly limited impact on the euro since no new measures are expected and devoid of any razzmatazz during the presser. The euro is dancing above the 1.1400 level ahead of the policy meeting.

The meeting should be more about testing (ECB) President Christine Lagarde's communication rapport with the markets rather than announcing any new measures.

The ECB's recent measures, including last month's decision to expand the coronavirus bond-buying programme, have managed to compress the EUR risk premium with EUR/USD trading expensive versus the dollar on a short-term bias.

The Dollar Index has sunk to a five-week low as stocks have rallied. Optimism is building for prospects of a more robust recovery in the Eurozone than in the US or the UK, as the euro rose to a four-month high of $1.1446.

Positive market sentiment which has boosted the euro against its peer the safe haven US dollar, reflect optimism over a potential coronavirus vaccine and a Federal Reserve official's calls for continued monetary policy support. The US dollar has been weakening as vaccine news encourages riskier investments which has bolstered investors' appetite for risk, with the S&P 500 rising 0.9 percent and the US 10-year Treasury yields rising to 0.632 percent, in tandem with the risk-off flows.

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On Tuesday it was reported that Moderna’s potential Covid-19 vaccine produced immune responses in patients in an early stage trial.

The euro is benefiting the most from the optimistic mood in markets and could rise further if EU leaders approve a coronavirus fiscal package.

The euro has gained for the past four straight sessions, up 1.12 percent. Longest winning streak since Thursday, June 4th, 2020 when the market rose for eight straight sessions. Up 6.72 percent from its 52-week low of 1.0654 hit Thursday, March 19th, 2020.

The euro hit a nadir in late March. Month-to-date it is up 1.57 percent versus the dollar and year-to-date the euro is up 1.76 percent versus the dollar.

We expect Thursday's ECB meeting should not change much with EU fiscal policy a more important short-term driver for the euro. It is the consensus view that the European Central Bank will expand the EUR1.35 trillion Pandemic Emergency Purchase Programme (PEPP) in the autumn to meet governments' considerable financing needs. These financing needs should reach EUR1.1 trillion in 2021, and we expect the PEPP, which was topped up and extended in June, to be extended again in the autumn until 2022.

Behind the scenes, however, the ECB has taken its foot off the gas pedal. Net weekly purchases in its two bond buying programmes have been lower in July than in June and well off post-pandemic highs. The impression on markets is not obviously one of an ongoing whatever-it-takes commitment to close the output gap and restore inflation to mandate-consistent levels, and this dampens a bit at the margin the efficacy of the commitments made in June.

The parsimonious signal will give added weight to ECB President Christine Lagarde's comments on the total amount, pace and allocation of purchases. Nevertheless, we expect bond markets to remain serene, with short-term rates well kept at very low levels and the yield curve remaining under the influence of the ECB for a long time.

All the same, we do not expect any new measures to be announced at the Thursday meeting. Therefore, the Euro’s recent four-day rally is not out of juice, not just yet. EU leaders meet on July 17-18 to debate the European Commission's proposed EU recovery fund.

Fueling the rally has also been in part by optimism over the upcoming meeting between EU leaders in Brussels to haggle over a proposed fiscal response to the coronavirus crisis.

The economic backdrop ahead of the ECB's Thursday meeting is calmer than it was at the previous meeting in June, but the ECB will probably reiterate that it remains vigilant and willing to intervene further if necessary.

Mr Janot is a Senior Dealer, Mansa X Fund, a product of Standard Investment Bank

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