Euro braces for ECB Draghi

Falling PMI shoe

The decline in the eurozone August composite PMI (combining services and manufacturing PMIs) to 52.5 from July’s 52.8, was not big news. Neither was Italy’s return to contraction territory when its composite PMI fell below 50.0 for the first time since November, nor France’s composite PMI, remaining in contraction territory for the fourth straight month.

Yet, the more salient release was from Germany, whose August composite PMI slipped to 53.7, the lowest since October. The chart below illustrates how the PMI indices were the last among Germany’s main business surveys (ZEW & IFO) to highlight the latest deterioration in business sentiment owing to Western sanctions on Russia and the escalating uncertainty from the spillovers on the eurozone’s largest economy.

Draghi’s policy options

Moving to tomorrow’s ECB governing council decision, markets remain split as to whether additional rate cuts will take place, such as a 10-basis-point reduction in the interest rate corridor (the difference between the ECB’s marginal lending and deposit facilities) from the current 25-bps gap. Some may argue that the euro’s 6% decline from its May highs would have helped the ECB address the deflationary risks and earn it time before having to move again. Yet, a rate cut could well be a possibility to incentivise banks to lock up an even lower rate than the current 0.15%, at the first targeted long-term refinancing operation due later this month.

The ECB’s staff forecasts on CPI and GDP are another component to the decision, as these are expected to be revised down for 2014 and 2015, with little or no change for 2016 projections.

ECB president Draghi may also use Thursday’s conference to shed more light on its plan to purchase asset-backed security (ABS) as a way to deepen the credit easing and liquidity expansion processes in the eurozone. The ECB has already selected BlackRock, the world’s biggest money manager, to assist in designing and implementing the ABS programme.

EUR/USD, EUR/CAD, EUR/AUD

The euro’s latest selling wave emerged on Friday following the release of fresh four-year lows in eurozone CPI at 0.3% y/y. We made the case for fresh decline in EUR/USD and EUR/AUD in last week’s piece. The latest upside data surprises from the US (record high gains in August factory orders and two-year highs in construction spending) and Australia (3.1% GDP in Q2 vs an expected 3.0% and hawkish RBA talk on housing), could well highlight fresh declines in EUR/USD and EUR/AUD, but not before a possible post-ECB bounce in the single currency. Such a move could be confounded with the start of an uptrend, but not so fast. EUR/USD is apt to wage a short-lived recovery to 1.3190-1.3200, especially on disappointment from any of the components of the August US jobs report.

EUR/AUD eyes further declines from its current 1.4060s, nearing the June 2013 lows of 1.3370, followed by the bottom of the two-year trend channel at 1.3520.

EUR/CAD is another alternative for EUR bears after the Bank of Canada issued a brighter assessment in today’s Monetary Policy Report, removing “soft landing” from its policy statement. Following the breakdown of the 2012 trendline, EUR/CAD eyes the 100-WMA near 1.4020.