The European Central Bank will publish the minutes of its September policy meeting on Thursday at 11:30 GMT as policymakers find themselves increasingly under the spotlight for their diverging views. Differences over the deflationary impact of a stronger euro and how the pandemic asset purchases are conducted have been sending conflicting signals about where the ECB stands on these issues, casting doubt on the Bank’s ability to respond effectively should another round of stimulus be required. In the meantime, the single currency has been taking its cues from the US dollar, as its rally fizzles out.
ECB truce put to the test
One of Christine Lagarde’s priorities when she took over the helm at the ECB was to unite a Governing Council left divided by her predecessor, Mario Draghi. But although her efforts paid off at the height of the pandemic crisis in March and later again in June when policymakers approved a total of almost €1.5 trillion in asset purchases, the fragile truce between the hawks and the doves could soon unravel, if it hasn’t already.
With the risk of a full lockdown growing by the day in many Eurozone countries, as the second wave of the COVID-19 outbreak shows no sign of slowing, Europe’s much-prized V-shaped recovery is looking “a little bit more shaky” in Lagarde’s own words. However, despite the sudden deterioration in the economic outlook, which is directly tied to the tightening in virus restrictions, ECB policymakers are at loggerheads about the severity of the downside risks.
Mixed messages
Some, like Vice President Luis De Guindos, see no immediate need for additional stimulus, while others, such as Executive Board Member Fabio Panetta, are calling for pre-emptive action. The case for pre-emptive stimulus in the euro area has been strengthened following a second consecutive month of year-on-year fall in consumer prices in September.
The rising threat of deflation has even prompted the Bank’s chief economist, Philip Lane, to contradict Lagarde. Back in September, Lane wrote in a blog post about how the euro appreciation has “significantly muted” the forecasts for core inflation a day after Lagarde tried to play down worries about the negative effects of a stronger exchange rate.
Can Lagarde rein in dissents?
But finding a middle ground between the overly cautious and the less cautious views is not Lagarde’s only problem. Some policymakers like Germany’s Jens Weidmann are unhappy about the new powers given to the pandemic emergency purchase programme (PEPP) where issuer limits on the amount of government bonds the ECB can buy as a portion of the country’s total debt do not apply. Italian government bonds have been the main beneficiary of this flexibility, fuelling German concerns about the legal remit of the ECB’s non-conventional policies.
The growing rift poses a major communication challenge for the ECB, and more specifically, for Lagarde, at a time when the Eurozone economy is facing unprecedented risks from the global pandemic. Should Lagarde fail to rein in the dissenters, the euro is likely to face increased volatility as investors become nervous about the lack of a clear policy direction.
Euro guided by dollar moves as ECB divided
So far, the euro has suffered only a mild pullback even as Europe’s recovery stumbles, but that’s mainly been down to the limited upside for the dollar. If the minutes indicate policymakers are divided about the need for further stimulus and are nowhere close to being able to decide on new measures soon, the euro could enjoy a short-term boost, clearing immediate resistance at the 50-day moving average around $1.18 before challenging the late September peak of $1.1871.
On the other hand, if the minutes are more dovish than anticipated, the euro could retreat towards the 38.2% Fibonacci retracement of the June-September up leg at $1.1689 before revisiting the September trough of $1.1611.
In the more medium-term timeframe, however, unless the ECB was to hint at a rate cut, flagging further stimulus in the form of more asset purchases would be positive for the euro while foot-dragging by policymakers would only harm the Eurozone’s recovery prospects, hurting the currency as a result.
