EUR: Medium-term outperformance likely beyond ECB meeting – Nomura

The ECB is widely expected to take a step towards normalisation this week, as 1) the economy continues to expand, and 2) a reduction in QE looks inevitable, according to analysts at Nomura.

Key Quotes

“We also think reduction in the monthly purchases is inevitable, expecting a EUR20bn cut to EUR40bn per month, from January to June 2018. We judge that risks are tilted toward a longer extension (nine months), although a six- to nine-month extension is within the market consensus range, in our view.” 

“If the ECB announces just a six-month extension as we expect, the outcome would be viewed as slightly hawkish. Even though the Bank is likely to keep both its rate and QE forward guidance unchanged, the ECB policy stance should remain the market focus into Q1 next year, as the next communication on QE extension should come at its March meeting.”

“We are seeing increased EUR sensitivity to rate spread and data surprises, which should continue under the scenario outlined above, supporting EUR. In contrast, a nine-month extension would be more of a dovish outcome, and could entail a slight EUR depreciation. If the ECB were to commit to an even longer extension (e.g. 12 months, unlikely to us), the decision would lead to a sell-off in EUR, as rate hike expectations would be scaled back even further.” 

“After the likely announcement of the reduction in QE asset purchase next week, FX market focus on ECB policy should decline in the near future. In contrast, the December FOMC will be clearly a live meeting, with nominations for the Fed Chair and tax policy discussions in parliament the key events for the FX market. EUR/USD short-term volatility should come mostly from the USD side, while European politics could also generate some short-term volatility in the market.” 

“Nonetheless, in the medium term, ECB policy normalisation is clearly backed by the strong economic fundamentals, as the ECB is becoming increasingly confident about the broader economic expansion and progress in structural reforms. The basic balance of payments have also been recovering, supporting EUR. Thus, we see EUR outperformance continuing into 2018, and we recently added EUR long exposures against JPY and NZD.”