European Central Bank returns from holiday - leaves policy unchanged

FTSE Steady as Defensives Rise; Financials Falter

European Central Bank returns from holiday - leaves policy unchanged

Only 15 of 66 economists polled by Reuters had expected the European Central Bank to announce a reduction of its monthly asset purchases at Thursday's policy meeting - a sharp reversal from a month ago when slightly over half of respondents expected such a move. However, the silver lining is the real economy.

The euro's sharp gains in recent months have already forced the European Central Bank to slightly lower its inflation forecasts for 2018 and 2019 by 0.1 percentage points to 1.2% and 1.5% respectively. The ECB could defer the decision until its October meeting, leaving us in suspense for a few more weeks.

Rather than obsessing over smaller under- or over-shootings of the inflation target, it is time to worry about potential hangovers and the integrity of the punch bowl. The Euro to Pound exchange rate traded at around 0.9200.

Mario Draghi won't miss the opportunity to mention the euro's recent appreciation as he prepares to reconfigure the eurozone's stimulus settings, economists say.

The ECB will be closely watched for any signs that the central bank has become uncomfortable with the euro's recent strength, a concern that could delay it from winding back its massive monetary stimulus scheme. The fresh remarks suggest President Mario Draghi and Co. will gradually move away from the easing-cycle as 'the risks surrounding the euro area growth outlook are broadly balanced, ' and the European Central Bank may continue to soften its dovish tone over the coming months as officials argue 'reflation has replaced deflation.' The Euro rallied following the European Central Bank meeting, with EUR/USD clearing the 1.1500 handle to end the day at 1.1630. Low inflation had raised concerns it could turn into a chronic downward spiral of wages and prices that would kill off growth and investment. According to Bloomberg news, officials may not have a complete plan until December. The size was reduced in March from Euro 80 billion. Postponing the decision will only have a short-term negative impact, and I believe this will create another opportunity to buy the dips towards 1.17-1.18 levels. Above 1.1495, the euro's medium term positive trend will not be compromised. Various reports have suggested the bank is getting cold feet about that now because the euro has risen sharply against the dollar in the last couple of months, something that could dampen the economic recovery by making exports less competitive on world markets. That is because the bank will run out of eligible government bonds to purchase after running the program since March 2015. This led some analysts to think that the markets may have misjudged the ECB's readiness to begin tightening policy.

How the euro will react to Thursday's meeting will depend very much on the line that Draghi will chose to take. The euro will likely clear positions on both directions before taking a steady path. Risk averse traders could prefer turning flat before a potentially bumpy session on Thursday.

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