Traders hope ECB chief Draghi will work magic on euro, expand monetary easing

ECB president Mario Draghi at the Euro Finance Week in Frankfurt, Germany, on Nov 20, 2015.
ECB president Mario Draghi at the Euro Finance Week in Frankfurt, Germany, on Nov 20, 2015.PHOTO: BLOOMBERG

EDINBURGH (BLOOMBERG) - European Central Bank president Mario Draghi needs to come up with something to surprise currency traders next week or risk a euro rebound that would threaten his efforts to boost inflation.

The good news for him is that strategists are gaining confidence he will pull it off and exceed the market's expectations for monetary easing at the Dec 3 policy meeting.

Forecasters are cutting their year-end and first-quarter euro estimates at the fastest pace since March, when the start of the central bank's bond-buying programme sent the currency tumbling to a 12-year low. And options signal there is a 70 per cent chance the euro will match that low this year, up from 18 per cent when the ECB last met in October.

"He's going to pull a rabbit out of the hat - we're just not sure what that rabbit will be," said Mr Steven Bell, London- based chief economist and director of macro strategies at BMO Global Asset Management, which oversees about US$244 billion (S$343 billion). "The euro is going down heavily."

Mr Bell predicts the shared currency will drop below parity with the US dollar next year, after it sank to US$1.0566 on Wednesday (Nov 25), its weakest level since April and approaching this year's low of US$1.0458 on March 16.

Ways that Mr Draghi might exceed investors' expectations include lowering the ECB's minus 0.2 per cent deposit rate by 0.2 percentage point, Mr Bell said. Futures prices compiled by Bloomberg suggest that only a 0.1 percentage-point cut is fully priced in.

The ECB chief may also expand the bank's quantitative-easing plan to include assets such as corporate and local- government bonds or remove the rule preventing it from buying securities that yield less than the deposit rate, according to Mr Bell.

A weaker euro is key to the ECB's ambition to boost inflation to 2 per cent. Yet even after a 12 per cent slide this year as policymakers increased the money supply, prices are barely rising across the 19-nation economy. Part of the reason is the euro's mid-year rally as a meltdown in emerging markets prompted investors to unwind riskier trades funded in the currency.

The risk for Mr Draghi - and the euro - is that he fails to live up to the growing speculation that he has a surprise in store.

While the ECB chief has been dropping hints about extending stimulus since the bank's Oct 22 meeting, he has been vague about the details. And further euro losses are by no means assured.

Since that gathering, strategists surveyed by Bloomberg have cut their median year-end euro forecast by three US cents to US$1.07, and their first-quarter outlook by two cents to US$1.06. Those predictions still put the shared currency slightly stronger by Dec 31.

"For the euro to continue going further, it needs something more than the spin," said Mr Neil Jones, the London-based head of hedge-fund sales at Mizuho Bank. "If Draghi actually does come with some decent measures, then we can still get a sharp move lower. We need something physical now. We need the start button to go on further QE."

Mr Jones said he is confident Mr Draghi will either cut the deposit rate by as much as 0.25 percentage point or widen the scope of the 1.1 trillion-euro (S$1.64 trillion) QE programme, and sees the euro falling below US$1.05 before year-end and less than US$1 in 2016.

Not everyone is convinced Mr Draghi will do enough to satisfy markets. Some officials have argued that incoming data show they have no need to act next week. And speculation the Federal Reserve is preparing to raise US interest rates later in December, which should boost the US dollar, is just as priced in as ECB easing.

"Since euro-dollar has already depreciated in response to Mr Draghi's statements in recent weeks, it will be difficult for the ECB not to follow through on Dec 3 in order to prevent another retracement," said Mr Stephen Jen, co-founder of London- based hedge fund SLJ Macro Partners LLP and a former economist at the International Monetary Fund. "The ECB will not disappoint."