The ECB's big day - can the Euro rally?

The past few days have seen some overdue relief for the euro. The relentless selling in EURUSD took the pair briefly below parity before a rapid recovery propelled the single currency back into the mid 1.02s and a test of the 20 day moving average.

It’s fair to ask what the next move is. For the bulls, a push higher to retest the 1.0350 broken support is the clearest objective. For the bears, it’s all about trend continuation and another look below parity…

Thursday’s ECB meeting is one of the clearest catalysts for the pair, but as is so often the case in Europe, it’s not simple. There are also political issues in Italy, and question marks hanging over Russian gas supplies via NordStream 1.

The ECB

Inflation has tested the resolve of various central banks to stick with forward guidance. The ECB has resolutely defended their ‘policy sequencing’ so far, but perhaps forward guidance isn’t well-suited to this more volatile inflationary regime.

Nevertheless, until very recently, the central bank was expected to hike by 25bps at this meeting followed by a 50bps hike in September. But there are murmurs that the ECB could be ready to abandon this guidance. Reuters reported that a larger than expected 50bps hike is on the table, citing ‘two sources with direct knowledge of the discussion’.

The Fragmentation Tool (Transmission Protection Mechanism)

To ensure that monetary policy is successfully transmitted throughout the eurozone, the ECB is set to propose an anti-fragmentation tool. Essentially this is a spread management mechanism to manage the interest rates of peripheral, high debt economies such as Italy, and the largest eurozone economy, Germany.

But this is fraught with obstacles. It’s hard to define the ‘correct’ spread between two very different economies, and there are political issues to contend with too. Namely, the prohibition of direct government financing, and the conditions (currently suspended) surrounding government debt levels.

This will be an especially tricky issue for the ECB to contend with, and legal challenges to the mechanism are anticipated.

Italian Politics

Once again, the Italian government is falling apart at the seams and there’s talk of yet more elections. The coalition is threatened by disagreements over a recent ‘cost-of-living’ vote, and the political direction of the country.

Draghi offered his resignation, but President Mattarella asked him to try again. Today’s debate will shape the course of Italian politics, at a time when the country needs stable leadership.

Gas Flows

There could be better news on the horizon, as fears that the Nord Stream pipeline would not restart after maintenance appear to be ill-founded. Vladimir Putin said that Russia would fulfil their contractual commitments to supply natural gas to Europe via the Nord Stream pipeline, as long as sanctions do not prevent additional maintenance on components.

Recently, a turbine was sent to Siemens in Canada for repairs, but could not initially be returned due to the sanctions. Another turbine is due for maintenance on the 26th of July.

Huge challenges lie ahead for the eurozone. Can the ECB boost market confidence and support the euro?

Not investment advice. Past performance does not guarantee or predict future performance.