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Daily FX StrategyECB preview: EUR to take fright from QE-lite?

FX6 March 2014

DM %ch vs USD past 24 hrs

-1.0% -0.5% 0.0% 0.5% 1.0%

JPYCHFEURSEKGBPNOKNZDCAD

AUD

Source: Thomson Reuters

EM % ch vs USD past 24 hrs

-0.5% 0.0% 0.5% 1.0%

KZTHRKRUBCZK

ILSTRYCNY

KRWZARINR

Bottom 5 Top 5

Source: Thomson Reuters

Two year German-US spread

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EUR/USD (lhs)Ge-US 2Y Spread (rhs)

Source: Markit

Currency view 24h call

USD: The Ukraine-Russia crisis has stabilised somewhat over the last 24 hours,but a failure of mediators to make a major breakthrough means sentiment is atbest fragile. Discussions today will focus on US-Russia dialogue in Rome andan EU Summit in Brussels, following yesterdays $15bn offer of financial aid toUkraine. For now volatility in major FX markets is contained, but macro events inthe EZ (ECB meeting today) and US (labour report tomorrow) are set to play agreater role near-term. USD Index could easily find itself testing 80.

EUR: The major macro event today is an ECB policy decision (full preview onpg2). Increased talk of significant policy easing leaves us somewhat concernedthat absent it today (or a strong hint for next month), the EUR might rise sharply.More minor easing, i.e. halting SMP sterilisation, will probably have only atransitory EUR impact. Look out for the ECBs 2016 inflation estimate. A 1.5% orlower forecast would be consistent with a need for looser policy. Elsewhere,markets are set for a very soft US payroll report tomorrow, after poor ISMemployment and ADP figures. Overnight the Feds Beige Book highlighted theon-going negative impact of severe weather. For now the FOMC is unlikely to bepersuaded from its tapering path. Barring a major surprise from the ECB, wedoubt EUR/USD can make headway beneath 1.3700 support.

JPY: USD/JPY is enjoying decent support on the back of this weeks recovery inUS 10Y Treasury yields, from a low point near 2.60% to the current 2.70%.

Although a break of resistance in the 102.75/85 risks a move toward 103.5, aweak NFP or deterioration in the Ukraine-Russia crisis could easily seeUSD/JPY reverse. Ultimately we believe USD/JPY is a 110 story this year, butwe are cautious for the immediate future.

AUD: Political or financial crises remain largely localised for now in the EMspace. This is confirmed by relatively subdued volatility in the liquid G3 FXarena. Risk sensitive currencies are even on the rise, with the likes of AUDbenefitting overnight from good retail sales and trade balance data. This is

firming confidence that the RBA has entered an extended period of steadyinterest rates. More clarity might come overnight with RBA Governor Stevensmeeting with the House Economics Committee. Despite positive sentiment, wedo not believe AUD/USD can sustain a move above 0.90.

Key data releases and events

Country GMT Data/event ING forecast Consensus Prior

United States 1230 Feb Challenger Job Cuts (YoY%) - - 11.61330 Weekly Initial Jobless Claims 340 336 3481500 Jan Factory Orders (MoM%) - -0.5 -1.5- Feds Dudley (1315), Plosser (1800), Lockhart (2300) speak -

Eurozo ne 1245 ECB rate (%) & press brief (1330) 0.25 0.25 0.25

Germany 1100 Jan Factory Orders (MoM%/YoY%) - 0.9/7.5 -0.5/6.0UK 1200 BoE Bank Rate (%) APT (bn) 0.5/375 0.5/375 0.5/375Canada 1500 Feb Ivey PMI (SA) 50.0 53.1 56.8Hungary 0800 Jan P Ind. Production (MoM/YoY%) -/4.7 -/- -1.9/4.4Czech Rep 0800 4Q13 GDP (QoQ/YoY%) -/- -/- 1.6/0.8Source: ING

FINANCIAL MARKETS RESEARCH

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ECB preview: EUR to take fright from QE-lite?Todays ECB decision has markets debating what new policy stimulus tools might be unveiled. However, with a November-style aggressive policy move (ie, rate cut) not on the agenda, it is hard to envisage the euro suffering a sustained sell-off. TheECBs inconsistency of policy in recent months injects added uncertainty to events, as does todays first release of projectionsfor inflation in 2016. Unless accompanied by a strong hint of more forceful policy easing soon, even a low 2016 CPI projection

of 1.5% YoY is unlikely to see EUR/USD make much headway beneath 1.37.Our sense is that with the economic recovery slowly progressing, the ECB ideally wants to retain a threat of negative depositrates and full quantitative easing (QE) for as long as possible, without actually executing on it. In the meantime, this leaves theECB with a challenge to convince markets that its forward guidance for steady or easier policy is credible. Dovish commentary,in an environment of inflation far below target, and piecemeal quasi easing tweaks will therefore take centre stage for the timebeing. Markets are far from convinced, with the euro stubbornly strong.

Barring a major surprise, consensus has converged on a view that the ECB will today announce an end to the sterilisation ofbond purchases made as part of its defunct Securities Markets Programme (SMP) in 2010-12. As Figure 1 shows, the SMPamounts to around 175bn. If this is to be no longer be sterilised, it will effectively add to excess liquidity at the ECB (currently

114bn), taking it toward the 300bn mark. Recall that excess liquidity at the ECB has been a key focus in recent times, with

the ECB first highlighting, and then diluting, the link between falling excess reserves and tighter financing conditions.

Fig 1 ECB liquidity & Securities Market Programme (bn) Fig 2 EUR even stronger than many realise

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ECB excess liquiditySMP wkly purchase (x10 scale, rhs)SMP cumulative (rhs)

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EUR EER20

EUR EER39

EUR/USD (right)

(Jan09=100)

Source: Bloomberg, ING Source: ING, EcoWin, ECB

President Draghis attempt to downplay the link leads us to the view that the impact on the euro of any such policy decision willbe negative, but minimal and probably transitory. That said, were markets to interpret (or Draghi to hint) it as a step towardmajor QE soon, the EUR would fall much harder. This seems less than likely. Furthermore, we do not think an announcementtoday to stop sterilising the SMP is so clear. Constitutional arguments against QE are very much alive and quite how the ECBcan distinguish between the two is uncertain. Some argue that the ECB has received cover to make an SMP move by aBundesbank admission that it is open to such a change if it is suited to stabilising money markets and liquidity conditions. Wewonder though whether this is sufficient public backing for Draghi to forcefully push such an agenda.

Another major focus today are new quarterly ECB staff forecasts, which for the first time include inflation and growth estimatesfor 2016. Last time around (December), the ECBs mid-point estimate for 2015 inflation was 1.3% YoY and for GDP 1.5% YoY.Unless the 2016 CPI estimate is at least 1.6% YoY, it will be difficult for the ECB to explain why it is leaving interest ratesunchanged at 0.25%. This will be a major communications challenge for Draghi today.

Indeed, in Draghis words only on Monday, EZ inflation is way below target. There is evidence that the current 0.8% YoYcould prove the cycle low, but this is not guaranteed. On this front, the ECB is seen again refraining today from citing thestrength of the euro as a downside risk for inflation. This is somewhat confusing. As Figure 2 shows, the euro is strong by any

measure. But a look at the ECBs broader, but less publicised, EER39 measure, shows the euro now considerably higher thanits peak of 2011. The ECB will be conscious of this, but whether it is prepared to signal greater concern today is doubtful. Weretain a view that EUR/USD ultimately comes lower, later this year. However, if the ECB delivers the bare minimum today andtomorrows US labour report disappoints, EUR/USD might find itself pushing through major resistance at 1.3850.